To date, more than 35 million Americans have filed for unemployment as the COVID-19 pandemic has wreaked havoc on the nation’s economy and put many businesses on temporary pause. And while there’s hope that as the United States begins to roll out its reopening plan many of these workers will return to their previous jobs, in the meantime the CARES Act has provided these out-of-work Americans with unemployment benefits that match what their previous earnings were.
In some cases, these inflated unemployment benefits may even exceed what workers previously earned. For context, under normal circumstances, unemployment benefits account for about 45 percent of a worker’s earnings.
But make no mistake about it – unemployment benefits are not free money. In fact, it’s considered taxable income by the IRS. And if you’re not taking the steps to withhold taxes from your unemployment benefits now, you could be in for a rude awakening when you go to file your 2020 taxes in early 2021.
Here’s a closer look at what you need to know if you’re among the tens of millions of Americans currently receiving unemployment benefits:
Taxes and Your Unemployment Benefits
First, it’s important to note that unemployment benefits are not subject to all of the tax withholdings that your usual paycheck is. For instance, it is exempt from Social Security and Medicare taxes. However, you’re still on the hook for federal taxes and in some cases state taxes. Secondly, it’s also important to note that you’re not required to withhold eligible taxes from these checks. However, financial experts strongly suggest doing so to avoid a surprise in the future – especially right now with unemployment benefits much greater than what they normally are.
Let’s take a look at your options…
#1: Withhold No Taxes
We don’t recommend this option, but if you do go this route and return to work soon, be sure to increase your withholdings to help make up for the taxes you didn’t withhold on your unemployment checks.
#2: Elect to Withhold Taxes
The recommended option, you’ll need to fill out a W-4V form to withhold taxes from your unemployment benefits. How you do file this form depends on the state where you live. For most Americans, it can be filed through the benefits portal. If you want to make a change or stop your withholding at any time, you can request a new form through your respective state’s unemployment office.
#3: Send the IRS Estimated Tax Payments
If you don’t want to withhold taxes, we’d suggest sending estimated tax payments to the IRS on a quarterly basis. This will help prevent a massive tax bill when you’re ready to file for the 2020 calendar year. What’s more is if you overpaid when making your estimated payments, you’ll get it back in the form of a refund. While this requires some self-discipline as it pertains to setting aside money from each unemployment check yourself, it’s a good way to avoid a surprise come tax time.