By law, unemployment compensation is taxable and must be reported on a recipient's 2020 federal income tax return. Taxable benefits include any of the special unemployment compensation authorized under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted this spring.
Voluntary Tax Withholding Option
When you first apply for unemployment benefits, you may opt to have taxes automatically withheld from your payments. Federal law allows any recipient to choose to have a flat 10% withheld from their benefits to cover part or all of their tax liability. To opt in, fill out IRS Form W-4V (Voluntary Withholding Request) and give it to the agency paying the benefits (do not send it to the IRS). Note, even though the automatic withholding option is purely voluntary, it can ward off an unexpected tax bill when filing next year's return.
If a recipient does not choose to have taxes automatically withheld, or if the 10% withholding is not enough, they can make quarterly estimated tax payments instead. The payment for the first two quarters of 2020 was due on July 15th. Third and fourth quarter estimated tax payments are due on September 15, 2020, and January 15, 2021, respectively. For more information, see Taxlete's overview of Estimated Tax Payments on the Small Business page.
Check Your Tax Withholding
Unemployment compensation recipients who return to work before the end of the year can use the IRS Tax Withholding Estimator to make sure they are having enough tax taken out of their pay. The online tool can help workers and pension recipients avoid or lessen their year-end tax bill, or alternatively, it can help estimate desired refund amounts.
For a quick check, locate the tax liability amount on your 2019 tax return (Line 16 on Form 1040), and also locate your total adjusted gross income amount (Line 11b). Divide your total liability by your AGI to determine your effective tax rate. If you opted to have taxes automatically withheld from your unemployment compensation and your effective tax rate is greater than 10%, you may want to consider withholding additional taxes from your unemployment benefits. Under this scenario, you will likely owe additional taxes on your unemployment compensation when you file next year's return.
Proof of Benefits Received
In January 2021, unemployment benefit recipients should receive a Form 1099-G (Certain Government Payments) from the agency paying the benefits. The agency paying the benefits also provides this form to the IRS. The form will show the amount of unemployment compensation recipients received during 2020, as well as any federal income tax withheld. Taxpayers must report this information, along with their W-2 or 1099 income, on their 2020 federal tax return.
For more information, see IRS Publication 525 (Taxable and Nontaxable Income).