Last year was tough: you were downsized, your unemployment insurance benefits didn't come close to covering the expenses that your old salary did, and now -- guess what -- you discover that you might owe taxes on those benefits.
Unprepared for Unemployment Benefits
Unemployment checks don't have taxes withheld -- which leads most people to believe that they won't owe taxes on them come April 15th. And sometimes they don't -- benefits may come from state governments, unions, private insurance, and other sources, and the IRS treatment of unemployment benefits depends on the organization or entity paying the benefits.
Types and Treatment of Unemployment Compensation
Unemployment compensation generally includes any amount you received under state or U.S. unemployment laws. You should receive an IRS Form 1099-G showing what was paid to you and you can report it on your 1040, 1040A, or 1040EZ.
Government Programs That You Contribute To
Most unemployment insurance premiums are paid by your employer, and benefits are considered taxable income to you. However, taxpayers pay unemployment insurance premiums for governmental unemployment insurance. If these premiums aren't tax-deductable, the insurance payments are not taxable until they exceed the amounts you have paid for premiums. For example, if you paid a total of $1,700 for this insurance, and then received $2,300 in benefits, only the $600 exceeding the amount of premiums paid is taxable.
Repayment of Unemployment Compensation
Sometime, you might be required to repay unemployment compensation -- for example if your eligibility is denied or through some error you receive an overpayment of benefits. If you repay unemployment compensation you receive in the same year, you can adjust your income accordingly on your 1040, 1040A, or 1040EZ.
Repaying unemployment income claimed in a previous year doesn't get you an adjustment in this year's income; you only get to deduct it on your Schedule A if you itemize deductions. If the amount is more than $3,000, you may be allowed a deduction or credit for the year it was repaid if the repayment qualifies as an expense or loss incurred in your trade or business, or in a for-profit transaction.
You can choose to have federal tax withheld from your unemployment compensation if you think not doing so will get you in a bind on April 15th. However, times are often tough during periods of unemployment; it may make sense to keep all the money you can and then have more withheld from your paycheck when you get back to work.
Supplemental Unemployment Benefits
Benefits received from an employer-financed fund that you did not contribute to, are not considered unemployment compensation. They are taxable and subject to withholding, and may be subject to Social Security and Medicare taxes. These payments are reported on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ.
Private Unemployment Insurance Benefits
If you pay for private nonunion unemployment insurance, benefits are non-taxable until they exceed your premium payments. Any excess is then taxed accordingly (see the example in the section under "Government Programs That You Contribute To)."
Union Unemployment Benefits
If your insurance is a benefit that you pay for with your regular union dues, the income is taxable to you. If you receive benefits from a union fund (not covered by your regular dues), then only income that exceeds the amount you have paid for premiums is taxable.
Guaranteed Annual Wage
If you have a union agreement that guarantees you a certain annual income regardless of periods of unemployment, that entire amount is considered taxable wages.
A state's employees are not always covered by its unemployment compensation laws. Unemployment income paid to these employees is considered fully taxable but is not counted as unemployment insurance but instead as income.
So once you know the source of your unemployment compensation you can correctly determine how it will be taxed. And hopefully your unemployed days are or will soon be behind you.