Planning

What You Need to Know About Paying Tax on Unemployment Benefits

Unemployment application Form with pen, calculator

The unemployed got some bad news last week: the Federal government estimates that it overpaid more than $14 billion in unemployment benefits. This amounts to roughly 11 percent of all unemployment payments, which the recipients will have to pay back.

When it comes to collecting unemployment overpayments, the Federal government only recovers about a quarter of its losses. In fact, there’s even a procedure in place for those who have received overpayments but aren’t able to pay the money back — they can even have the repayment amount and any subsequent fees waived. The only criterion is that the recipient must prove that they did not set out to purposefully deceive the Federal government.

How unemployment overpayments happen

The most common reason for overpayment is attributed to clerical errors that qualify an applicant for regular payment, when that person would normally not have qualified to collect unemployment. This includes people who quit their jobs, were fired for negligence, aren’t actively looking for work, or have found another job.

The overpayment amounts are significant, especially when viewed through the lens of strained state budgets; Colorado overpaid by $128 million in a single year and Indiana paid out more in incorrect benefits than correct ones.

Withholding tax now vs. paying it later

Overpayments aren’t the only concern for the unemployed. Even though taxes aren’t taken out of your unemployment check, you’re still expected to pay tax on the benefits you collect, which is taxed as regular income.

Additionally, any supplemental unemployment benefits coming from company-funded programs are not taxed as income, but as “wages.” Meaning: you’re going to get a W-2 for them at the end of the year and the IRS will tax you then.

In some states, you have the option to have taxes withheld at the time the unemployment check is issued. Generally, 10 percent is withheld from the check. This withholding is optional and recipients can elect to collect the entire amount and pay tax on it at the end of the year instead.

Collecting a larger check is tempting, but it’s wise to have the taxes withheld from your unemployment check. Taking a hit now is better than owing the IRS at the end of the year. If you end up with a tax refund at the end of the year instead of owing, that money can go toward any bills and expenses you incurred as a result of being unemployed.

If you still decide to not have tax withheld from your unemployment benefits, make sure to set aside a portion of each check (say 10 percent) in a high-yield, interest-bearing account.

1099-Gs and reporting unemployment on your taxes

When you receive unemployment compensation, you will get issued a 1099-G at the end of the year. This is how the IRS keeps track of any income received from governmental sources. You are required to report this as income and failing to do so might be one of the biggest tax mistakes you can make.

If you fail to report your unemployment benefits as income, it’s unlikely you’re going to end up in Federal prison for tax evasion but the fees and penalties associated with lying on your taxes are significant. And if you get audited — even if you’re completely clean — the process will be time consuming and potentially expensive. When it comes to paying taxes, honesty is always the best policy.

Reporting unemployment income on your taxes is easy — there are lines on your tax forms specifically for any 1099-G income. You can also deduct a number of expenses related to your job search such as transportation, relocation costs, and seminar fees. Even the fancy paper you print your resume on is tax-deductible.

Paying taxes on your unemployment income doesn’t need to be scary — the detriments far outweigh the benefits and you can feel better about any monetary investment you make in your job search.

Nicholas Pell is a freelance writer based in Hollywood, CA. He underpaid taxes on unemployment one year and had a gnarly bill because of it.