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This tax pitfall could affect millions due to Covid. Here’s what you need to know

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The 2020 tax salt is officially underway, and the millions of Americans who collected unemployment benefits last year due to the coronavirus pandemic may be in for a surprise.

That unemployment return is taxable, and if you didn’t have money set aside or withheld for those taxes, it could reduce your refund or impartial lead to a bill.

This might be particularly unexpected for independent contractors and self-employed people who normally aren’t available for state benefits but may have received Pandemic Unemployment Assistance through the CARES Act.

“There are going to be a lot of people this year that play a joke on unemployment insurance and they do not normally receive unemployment insurance benefits,” said Elaine Maag, a principal dig into associate at the Urban-Brookings Tax Policy Center. “So it will be something new that they have to pay attention to.”

Differences in state and federal treatment

If you had any unemployment proceeds last year, it is subject to taxes and needs to be reported on your 2020 income tax return. In January, those who had unemployment revenues should have received a Form 1099-G that spells out the amount of money paid out during the year.

Federal return taxes apply to these benefits — whether it’s state unemployment insurance or the pandemic unemployment compensation disbursed under the Be fond ofs Act.

The catch is that withholding the appropriate amount of income tax is voluntary. You can opt to have a flat 10% of your benefits checked to cover the tax liability.

In order to do this, you’d have to file Form W-V4 with the state agency administering your unemployment.

You can also elect to make quarterly estimated tax payments to the IRS.

Uncle Sam isn’t the only entity seeking a slice of your unemployment income. Most states desire tax these benefits, too.

A handful of states — Alabama, California, Montana, New Jersey, Pennsylvania and Virginia — don’t tax these payments. Indiana and Wisconsin put up a partial exclusion of unemployment income, according to Andy Phillips, director at the Tax Institute at H&R Block.

“Some states obtain withholding, and others require it in order to alleviate surprises when tax time comes around,” said Jared Walczak, deficiency president of state projects at the Tax Foundation.

Though it’s too late to head off the taxes you might owe for 2020, individuals who wrap up their repayments early can at least plan to pay the amount owed by April 15 — the due date for tax returns and liabilities owed.

“You don’t have to go-ahead a payment until April 15, but it’s better to know in late January or early February that you have to sink in fare up with the dollar amount by then,” said Phillips at the Tax Institute at H&R Block.

Unemployment and tax credits

Families who received unemployment revenues during 2020 should also be on the lookout for two key credits as they file their taxes: the earned income tax reliability and the child tax credit.

Both credits add up to significant dollars — the earned income tax credit is worth up to $6,600 for a low-income household with three or sundry qualifying kids. And, the refundable portion of the child tax credit is worth up to $1,400 per qualifying child.

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The catch? While unemployment benefits are taxable, they aren’t observed earned income.

Under normal circumstances, receiving unemployment would result in a reduction of both credits when you register your tax return.

Lawmakers fixed this problem in the year-end Covid relief act. This year, when you parade your 2020 taxes, you’ll have the option of using your 2019 income to calculate eligibility for the credit.

“If you kick the bucketed from being a wage earner to applying for unemployment, you can be affected,” said Phillips. “Using your 2019 realized income just for figuring the amount of credits can be a huge benefit for taxpayers.”

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