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Unemployment Tax Break Means up to $10,200 Tax Free

by Apr 9, 2021Tax Accounting

Before the American Rescue Plan Act (ARPA) was signed on March 11, 2021, unemployment compensation was taxable income, and now ARPA provides a new federal tax break for unemployment benefits received in 2020. It now allows for the first $10,200 of 2020 unemployment benefits to be tax free, or $20,400 for married couples filing jointly, (for households reporting an adjusted gross income less than $150,000).

For Taxpayers Who Filed Before ARPA

ARPA was enacted in the midst of the 2020 tax filing season after the tax returns for millions of Americans had already been filed. After ARPA was signed in March, the IRS asked those taxpayers not to file amended returns, as the federal agency worked out the processes for adjusting to the new law.

They have now announced a plan for compensating those early filers. For those who filed before March 11, the IRS has confirmed they now have a process in place to automatically recalculate the benefit amounts subject to taxation.  Tax overpayments will be automatically refunded or applied to any taxes owed.  The first refunds will be issued starting in May.

The IRS states that they will begin the recalculations with taxpayers who are eligible to exclude up to the first $10,200 in unemployment benefits. Then they will turn their attention to returns for married filing jointly with eligibility of up to $20,400 in benefits exclusions and other complex returns.

Amended Returns Needed Only For Additional Tax Credits

For some taxpayers the benefits recalculation may make them eligible for other federal tax credits or deductions not on their earlier return.

One example of this situation is when the IRS adjusts returns for those who claimed an earned income tax credit, the unemployment benefits adjustment changes their income level, an increase in their Earned Income Tax Credit amount could be a possibility.  Based on a new taxable income amount, taxpayers should consider filing an amended tax return.

If You Have Not Yet Filed Your 2020 Tax Return

The IRS reports that software for tax preparation has been updated with the new changes. If you have not yet filed your 2020 tax return and you file electronically, you only need to answer the prompted questions when preparing your returns.

For more information please read New Exclusion of up to $10,200 of Unemployment Compensation for information and examples. If you plan to file with a paper return, instructions and an updated worksheet are currently available.

Tax Break Applies to 2020 Taxes Only

This new tax exemption applies only to unemployment compensation received in 2020.

For unemployment benefits received in 2021 and going forward, you should expect to pay federal tax on that full amount, and you should plan accordingly. You may consider having taxes withheld from your unemployment payments to avoid a tax bill on your 2021 return.

You should contact your state unemployment office to adjust the federal income taxes being withheld from your unemployment payments.


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