One in ten Americans were jobless by the end of August; a figure that has likely remained unchanged. Consequently, millions of people are continuing to seek state and federal unemployment benefits to stay afloat during the economic crisis caused by the coronavirus pandemic.
Unemployment may be the only thing helping American families get by right now, but they will face more troubles next year when tax season comes around. That’s because the IRS categorizes unemployment as taxable income, which means many people may see a large tax bill.
However, if you currently receive unemployment, there are ways to avoid — or at least lower — that amount. Forbes offers tips to help you prepare for the next tax season.
Plan Now To Prevent A Hefty Tax Bill Later
When you file for unemployment, you need to pay attention to the documents you complete because several states add federal and state tax withholdings when you enroll.
As you apply for this program, your state unemployment office may request a Form W-4V from you, an IRS file that lets you request a 10% withholding from your monthly benefit.
However, CPA Michele Cagan warns that this flat tax may not be adequate for every recipient. “It depends how much you worked during the year, what other income streams you might have. Some people get unemployment and have side gigs or their spouse is working,” she told Forbes. “It really depends on your personal situation.”
She suggests that you check out the IRS withholding calculator to determine if your withholdings are correct. The calculator requests details from your latest pay stubs and other forms of income and your last tax return.
Once you use this tool, you might realize that a 10% tax rate on your unemployment benefits isn’t enough. In this situation, or if you chose not to have your taxes automatically deducted from your payments, paying your taxes quarterly can help you avoid a large tax bill.
Paying your taxes every quarter has its benefits, but one significant drawback is that you have to determine your estimated payments by yourself. The IRS Form 1040-ES can help you navigate this process so you can calculate the correct amount you owe.
This strategy isn’t suitable for everyone, such as those living on a shoestring budget. And if you miscalculate your estimated taxes, the IRS will send a hefty fee. If you find yourself in this scenario, Form 2210 may be able to help you get it waived.
Ultimately, Cagan says your decision depends on your most pressing needs, particularly during the pandemic. “If you find out that you can’t pay your estimated tax and pay your rent, then don’t pay the quarterly estimate; pay your rent instead,” she noted. “The tax and penalty that you eventually might maybe have when you pay your taxes in April 2021 will be nothing compared to not paying your rent or having food to eat right now. Right now, cash is cash.”
Lost Wages Assistance
At the beginning of August, President Trump approved an extension for supplemented unemployment insurance using funding from the Federal Emergency Management Agency (FEMA), or lost wages assistance (LWA). LWA gives recipients an extra $400 every week, though depending on the state, it can be $300.
Recipients should give these payments additional thought because it may mean owing the IRS even more next April. The Department of Labor specifically said the federal government can tax LWA benefits. It also said that states can offer recipients the choice to have withholdings deducted automatically.
If you receive LWA payments and are unsure if it has already been taxed, look at your previous unemployment benefit statements, which you can do on your state unemployment department’s website.
The Earned Income Tax Credit (EITC)
If you think you might owe a large amount of money to the federal government next tax season, the EITC may be able to help. This program is a tax credit for low- to middle-income earners and can lower your tax bill. And since the credit is refundable, you may even get money back from the government.
Your income and the number of dependents you claim affect how much you receive, but it typically ranges from $538 to $6,660. According to the IRS, individuals who make less than $15,820 or couples who earn $21,710 are eligible for the EITC. Your unemployment benefits are included in this income, but you can also qualify under a separate set of requirements based on the income you’ve earned from a job.
All of this is extremely complicated, but the IRS provides an EITC Assistant to help you determine if you can receive this benefit. In many instances, the figures you enter in the Assistant are estimates because you don’t know when you will find another job, what your new wages will be, or how much unemployment you will get.
Cagen said, “Definitely not enough people take the EITC to begin with, and that’s because they don’t even know that they qualify. It’s still worth looking into.”
- Smith, Kelly Anne. “Collecting Unemployment? Take These Steps To Avoid A Tax Bill Next Year.” Forbes, Forbes Magazine, 26 Aug. 2020, www.forbes.com/sites/advisor/2020/08/26/collecting-unemployment-take-these-steps-to-avoid-a-tax-bill-next-year/.