Are Unemployment Benefits Taxable Income?

The IRS generally treats unemployment compensation as taxable income. If you don’t plan for this, or don’t withhold money from your weekly payments, you may owe money when you file your tax return. State tax rules vary, too, which can further impact your final tax bill. Knowing how to report unemployment correctly and how withholding works can help prevent costly surprises at tax time. 

A financial advisor can help you evaluate your tax situation, adjust withholding when necessary and create a plan that keeps you prepared while you navigate unemployment.

Do You Pay Taxes on Unemployment Benefits?

Yes, the IRS considers unemployment benefits taxable income. It treats these payments similar to wages when calculating your total income tax liability for the year. Your state unemployment agency will send you Form 1099-G, which shows the total amount of benefits you received and any taxes withheld. You must include this form when preparing your federal tax return.

It’s important to note that unemployment benefits don’t come with automatic federal tax withholding. Instead, you must choose to have taxes withheld from each payment by submitting Form W-4V to your unemployment agency. If you do not opt in, you may owe taxes later, even if you normally receive a refund.

While unemployment benefits are subject to federal income tax, they are not subject to Social Security or Medicare tax. 

In some situations, taxpayers who receive unemployment benefits with no withholding may need to make quarterly estimated tax payments to stay current with the IRS. Estimated payments help cover taxes owed when income is not subject to withholding.

Failing to make these payments can result in underpayment penalties, even if you pay everything you owe by the April deadline.

State Taxes on Unemployment Benefits

Whether your state taxes unemployment benefits depends on its individual tax laws. States fall into three general categories:

• States that tax unemployment: Most states with personal income tax also tax unemployment benefits, such as Colorado, Michigan and Vermont. 
• States that do not tax unemployment: Alabama, California, Montana, New Jersey, Pennsylvania and Virginia.
• States with mixed or partial taxation: Indiana and Wisconsin offer exemptions based on income or age.

Because rules vary so widely, it’s important to check your state’s tax website or consult with a tax professional to understand your obligations. State withholding is usually optional, just like federal withholding, which means you must request it if you want taxes taken out of each payment.

How Unemployment Benefits Affect Tax Liability 

Unemployment benefits increase your taxable income, which can reduce your refund or even create a tax bill. Because most unemployment recipients do not elect withholding, they often owe taxes when filing their return.

Unemployment income can also affect eligibility for tax credits, including:

If your unemployment benefits increase your adjusted gross income (AGI) beyond certain thresholds, you may lose these credits or receive a smaller credit amount.

How to Report Unemployment on Your Tax Return

Reporting unemployment benefits correctly is key to avoiding penalties and delays. Here’s how the process works:

• Form 1099-G: Your state unemployment agency issues this form, which lists your total benefits and any tax withheld.
• Schedule 1 (Form 1040): Unemployment benefits are reported under “Additional Income” in Part I.
• Adjusted gross income (AGI): Your unemployment increases your adjusted gross income (AGI), which may change your tax rate or reduce eligibility for certain credits.
• Paperwork match: The IRS electronically matches your tax return with Form 1099-G. Failing to report benefits correctly can trigger IRS notices and additional tax owed.

Special Situations: Overpayments, Fraud Notices and Repayments

Unemployment systems occasionally issue overpayments or encounter fraud problems. These situations can complicate tax reporting.

When it comes to repaying unemployment benefits, the timing matters. If repayment occurs in the same year you received the benefits, your taxable income may be reduced. If repayment occurs in a later year, you may need additional steps to adjust your taxes.

And should you receive a fraud or identity theft notice, or if your Form 1099-G lists benefits you never received, you’ll want to contact your state unemployment office immediately. They can issue a corrected form, and the IRS provides guidance for handling incorrect 1099-Gs due to fraud.

How to Manage Taxes When Receiving Unemployment

You can take steps while receiving unemployment to help manage your tax bill later. Strategies include:

• Elect voluntary withholding: Use Form W-4V to withhold a flat 10% from your benefits.
• Adjust spouse’s withholding: If you are married, your spouse can increase withholding at their job to offset taxes owed on unemployment.
• Set aside a percentage of each payment: Saving part of your benefit in a separate savings account ensures funds are available at tax time.
• Track your income carefully: Unemployment increases AGI and may affect credits or deductions.
• Use the IRS tax withholding estimator: The IRS’ estimator helps determine whether additional withholding or estimated payments are needed ¹ .

Bottom Line

Unemployment benefits are generally taxable at the federal level, and may also be taxed by your state. Whether you owe taxes depends on how much withholding you elected, your total income for the year, and your qualified tax credits. Knowing how these payments affect your tax return can help you avoid unexpected bills when filing time arrives.

Tax Planning Tips

• A financial advisor can help you create a tax plan to manage your liability. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you want to know how much your next tax refund or balance could be, SmartAsset’s tax return calculator can help you get an estimate.
• Mandatory distributions from a tax-deferred retirement account can complicate your post-retirement tax planning. Use SmartAsset’s RMD calculator to see how much your required minimum distributions will be.

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