Though the US economy has regained the 25 million jobs it lost in the pandemic, in most states, employment still trails behind pre-pandemic levels. For Americans who remain out of work, unemployment benefits can be a lifeline, helping them to make ends meet during difficult times. Unemployed workers, however, are still expected to pay some of the money they receive back to the government in the form of taxes. Planning ahead can save time and money.
Unemployment benefits paid in 2020 were treated differently for tax purposes due to the American Rescue Plan, which was signed into law in March 2021. That excluded qualifying individuals (and each spouse if married) from paying taxes on up to $10,200 of unemployment benefits. Today, however, we’re back to business as usual. If you received unemployment benefits in 2022, plan to pay taxes on that money when you file your income taxes in 2023.
You can have your state’s unemployment agency withhold a flat 10 percent from your unemployment check to help cover taxes. But, that isn’t always enough, and underpaying can lead to stiff penalties if you wind up owing $1,000 or more when you file your return.
To avoid underpayment penalties, prepay at least 90 percent of your taxes for the current year, or 100 percent of the tax on your previous year’s return, whichever is smaller. Make those payments quarterly using Form 1040-ES. Alternatively, you can make payments on your phone via the IRS2Go app, or by visiting irs.gov/payments. The IRS provides a useful tax-withholding estimator on its website that can help you figure out how much you’ll need to pay. If your income changed during 2022 — say you went back to work — be sure to revisit this tool and re-calculate how much you should pay.
State and Local Taxes
Each state treats unemployment income differently when it comes to taxes. If you live in Alabama, Alaska, California, Florida, Montana, Nevada, New Hampshire, New Jersey, Pennsylvania, South Dakota, Tennessee, Texas, Virginia, Washington state, or Wyoming, your unemployment income won’t be subject to any state taxes.
If you live in Indiana or Wisconsin, a portion of your unemployment benefits will be subject to tax. Other states may treat unemployment insurance as regular income and tax it accordingly. Visit the website of your state’s department of revenue to find out what income taxes your state requires. Additionally, your county, city, or town may levy income taxes of their own. Check with your local jurisdiction to see what you may owe.
Budgeting for Taxes
Determine what you’ll owe to the IRS, your state, and your county, city, or town. Budget for that and set aside a portion of each unemployment check so you’ll have it available when you need it.
A version of this article appeared in our partner magazine The Essential Tax Guide: 2023 Edition.