With Some Unemployed Workers Facing Surprise Tax Bills, States Start Providing Relief - Forbes

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Topline

Since unemployment benefits are usually considered taxable income by the federal government and most states, millions of out of work Americans could be faced with enormous surprise tax bills this spring—and these states are stepping in to ease the state burden.

Key Facts

Last week, Maryland passed and (on Monday the Governor signed) a $1.2 billion state stimulus package that will, among other things, repeal state and local taxes on unemployment benefits for 2020 and 2021 for low- and middle-income earners.

Earlier this month, Delaware Governor John Carney signed legislation waiving state income tax on all unemployment benefits paid out in 2020.

Last week, the Arkansas Senate voted to exempt unemployment benefits paid in 2020 and 2021 from state income taxes, sending the bill to the Arkansas House.

Michigan taxpayers will still have to pay state taxes on unemployment, but the state announced earlier this month that it will waive all penalties and interest for unemployment recipients who underpaid their state estimated quarterly taxes.

Nine states, including Florida and Texas, don’t levy any broad individual income taxes, while some others, including California and Virginia, already exempt unemployment benefits from their state income taxes.

Tax changes at the state level only apply to state and local taxes—the federal government still taxes unemployment benefits.

What To Watch For

Those who receive UI can choose to have federal income taxes withheld at a flat rate of 10%, but the actual taxes owed depend on the other income and deductions a recipient has. If you received unemployment benefits, you should have already received a 1099-G from your state spelling out the amount you received and any federal and state taxes withheld—although it pays to check the form to make sure it’s correct, and request a corrected form from your state if it’s not, since the IRS gets a copy of the form too.

Key Background

Last March, the $2.2 trillion CARES Act bulked up state unemployment benefits with an extra $600 per week from the federal government through July. It also created two new federal unemployment programs: one to extend benefits to part-time workers, gig workers and others not traditionally eligible, and one to extend the duration of traditional state benefits from 13 weeks to 24 weeks. President Trump took executive action in August to provide another $300 per week to claimants after the CARES Act benefits expired, but that money quickly ran dry. The $900 billion stimulus package Trump signed in December restarted $300 weekly benefits through the middle of March. Biden’s $1.9 stimulus plan (which is still in progress in Congress) would bump them up to $400 per week through the end of August.

Big Number

$50 billion. That’s how much Americans could eventually owe in surprise taxes based on the roughly $600 billion in unemployment insurance paid out in 2020, analysts from Goldman Sachs estimated earlier his month. “These surprise tax bills would reduce tax refunds or possibly even require net tax payments for vulnerable households, which may force some to cut back on spending,” they wrote.

What We Don’t Know

At the beginning of February, Rep. Cindy Axne (D-Iowa) and Sen. Dick Durbin (D-Ill.) introduced a bill that would waive federal income tax on the first $10,200 of unemployment benefitscollected in 2020. This provision was not included in a draft of the next stimulus bill crafted by Democrats in the House of Representatives, and it’s not clear whether it will make it into the final package Congress is aiming to pass by March 14, when the current round of enhanced federal unemployment benefits is set to expire.

Crucial Quote

“There is a strong legal argument that none of the benefits authorized as part of the pandemic response are taxable,” Brian Galle of the Georgetown University Law Center, Elizabeth Pancotti of Employ America, and Seth Hanlon of the Center for American Progress wrote in a January letter to the Biden administration to encourage the president to take executive action to exempt pandemic unemployment benefits from taxation. While that argument is strongest for the new emergency programs that have been created over the past year and weaker for traditional unemployment benefits, the three experts argue that the logistical challenges that will come with enforcing that distinction will be “much more manageable” if the federal government makes all 2020 unemployment benefits exempt from tax.