Do you have to pay taxes on unemployment?

Taxes and unemployment—preparing yourself

This may be disappointing news, but unemployment income is considered income and is taxed as such. With most jobs, you’re used to your tax responsibility being part of the equation—you know that the gross line on your paycheck isn’t what ends up in your bank account. Unemployment doesn’t automatically deduct those taxes for you. But you have a few options for how to pay taxes on your unemployment—here’s the pros and cons of each.

• Withholding your taxes. This is just like if you were getting taxes deducted from your regular paycheck. This means you won’t have as much of a surprise in your tax bill at the end of the year, and this may be a good option if you expect you’ll be unemployed for while or are just planning to weather a few months of scheduled unemployment. But this also means you’ll have less money coming in with each check, and you may be a position where you need the money immediately and to worry about the taxes later. You can automatically choose to have 10% of your check used for federal tax withholding, and depending on your state, you may be able to change whether you withhold or not each time you certify for benefits or increase the withholding to account for state and local taxes. Your unemployment office can answer questions about withholding paperwork and options.
• Waiting until next year to pay. This strategy is probably best if you expect your unemployment to be short-term, predictable, and/or not yield very much income overall. You should still expect either a larger tax bill or a smaller refund, since ultimately you will still owe taxes on the unemployment amount, but if you are only on unemployment for a short time or end up with a high-paying job after just a month of unemployment, you may be glad you didn’t choose withholding taxes per check. Note that the quarterly tax system mentioned below kicks in at roughly $5,000 of income, so depending on how much unemployment you think you’ll collect, waiting to pay might not be as much of a gamble as it sounds. You also can waive any penalty you incur for not paying quarterly taxes due to retirement, disability or disaster.
• Making quarterly tax payments. If you’ve ever freelanced or done gig work, you might be familiar with quarterly tax payments. On January 15th, April 15th, July 15th, and September 15th, you’ll send the IRS a check that considers your previous three months’ income and amounts to about a quarter of what your estimated tax will be for the year. If you don’t pay those taxes when they’re due, you may be subject to fees and penalties. This system helps engrain the idea that you’ll still owe taxes on your unemployment income, spreads the burden around overtime, and helps mitigate an unexpectedly large tax liability next year. It’s likely best for a long-term situation or when you know you’ll be collecting over $5,000 in unemployment income—and this could couple with 1099 freelance gig income, so quarterly payments could provide a solution for both tax conundrums.

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If this sounds overwhelming, here are a few tips to make quarterly payments go easier.

• Have an accountant do the math for the estimated payments. Any tax accountant should be familiar with quarterly payments, but find someone who specializes in freelance income, if possible, since they may have extra insight. Knowing the quarterly payment amounts allows you to budget and figure out what to save to fulfill your tax obligation.
• Prepare to put aside around 1/3 of each check. You can set up a separate account where you deposit this money, and only touch it when it’s quarterly tax time. This system not only ensures the money is ready for you when you need it, but it can help you figure out if you’re taking out enough or possibly even too much over time.
• You can pay your quarterly taxes online. There’s an electronic federal tax payment system, Direct Pay on the IRS website, IRS-approved payment sites, and if you e-file taxes, the ability to preschedule electronic funds withdrawal for e-filers. But you can also pay by phone and good old-fashioned paper check too!
• Schedule your payment dates. Put a reminder in your phone for the months when quarterly taxes are due—you may want to put it not just on the 15th, when payments are due, but on the first of the month to remind you to go over your accounts and prepare to make a payment soon.

Is there any good news about being taxed for unemployment?

Not really—there’s mostly just less disappointing news since you will overall still owe money on the unemployment assistance you receive. But here’s some unexpected things to consider.

• You may be in a lower tax bracket than you’re used to. Unemployment is, by design, not as much money as your former paycheck, and bringing in less money will obviously lower your overall taxable income. You may end up with a smaller bill or a bit of a refund compared to years past.
• Your state may not tax unemployment. 17 states don’t tax unemployment income or only tax it partially, so while you should expect to pay federal income tax, check to see if this applies in your state.

How do I pay taxes on unemployment?

Depending on your state, you’ll either receive a form 1099-G in the mail or need to go online to locate it. The form will list the amount you received in unemployment benefits and any federal or state tax you chose to have withheld. You’ll be able to use this information just like you would with a W2, whether you’re filing your taxes yourself or handing paperwork to your accountant.

Odds are, you won’t be unemployed forever, and you’ll have a more familiar tax situation in the future. But knowing you’ll have to pay taxes for unemployment is half the battle and helps mitigate any surprises in an already stressful situation.