Smart Tax Planning

How are unemployment benefits taxed?

Key Points
  • Unemployment benefits are taxed like other income sources, experts said. 
  • However, jobless workers won't pay Social Security and Medicare taxes like they would on their paychecks.  
  • Taxpayers should opt into tax withholding on unemployment benefits if given the choice, experts said. 
Local residents line up outside the food pantry Bed Stuy Campaign Against Hunger to receive free food during the COVID-19 pandemic on April 23, 2020 in the Bedford-Stuyvesant neighborhood of Brooklyn, New York. Due to increased levels of unemployment, the lines at the daily food pantry have been getting longer. (Photo by Andrew Lichtenstein/Corbis via Getty Images)
Andrew Lichtenstein

Millions of Americans who have filed for unemployment in recent weeks may be wondering if their benefits will be taxed.

The answer is yes.

However, there's a difference that could cause Americans to pay less tax relative to levies on a typical paycheck.

"Unemployment benefits are taxed just like income," said Michele Evermore, senior policy analyst at the National Employment Law Project.

The coronavirus pandemic pushed more than 26 million Americans to file for unemployment in the five weeks through April 18, erasing all the jobs created in the decade since the Great Recession.

The $2.2 trillion federal coronavirus relief package enacted last month enhanced benefits for unemployed workers. It did so in three primary ways: by raising the weekly pay amount, increasing the duration of that pay and extending benefits to previously ineligible groups like self-employed workers.

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Federal and state governments assess taxes on unemployment benefits like they do on income from a worker's typical paycheck, according to experts. Residents of states that don't levy an income tax wouldn't pay state tax on their unemployment checks.

However, there's a difference: Unemployment benefits aren't subject to Social Security and Medicare taxes (7.65% total). Employers withhold these taxes from a typical paycheck.

Jobless workers will receive a 1099-G tax form next year to reflect the income from their unemployment checks, Evermore said. That's similar to what occurs when a taxpayer get a tax refund from their state, she said.

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Income tax rates for unemployed individuals typically fall since income levels normally "go way down" in the year they collect jobless benefits, said Susan Houseman, research director at the W.E. Upjohn Institute for Employment Research.

Unemployment benefits replace about 40% of prior wages, according to a national pre-crisis average cited by the House Ways and Means Committee.

However, enhanced benefits provided by the recent stimulus package means that tax dynamic may not occur for some workers, Houseman said.

The stimulus package increased weekly jobless pay by $600 through July. Officials aimed to replace about 100% of prior weekly wages for the average American worker through that infusion.

As a result of the stimulus, the average worker can expect roughly $978 in gross unemployment pay per week.

Some workers, especially low- to moderate-income workers, could potentially be bumped into a higher tax bracket, Houseman said.

However, that will depend on many factors, such as their state of residence, the duration of unemployment pay and whether Congress extends the $600-a-week payments past July, which seems unlikely, she said.  

"Everyone is better off making more money, even if they're taxed on it," Houseman said.

Some states withhold taxes automatically from unemployment pay, though not all do, Evermore said.

It's best to opt into tax withholding if presented with the choice, she said, otherwise the enhanced jobless pay could catch taxpayers off-guard at tax time.

"It's better to pay the taxes now than wait until next year when it'll be a pretty big tax bill," she said.