Unemployment Benefits Are Taxable and May Affect ACA Tax Credit

Due to the economic impacts of the COVID-19 (coronavirus) pandemic, many individuals may have had to file for Unemployment Insurance (UI) benefits for the first time. For many, these benefits included federal Pandemic Unemployment Assistance (PUA), which provided an extra $600 per week to UI payments recipients from April through July. Ongoing UI benefits may also include $300 or $400 per week in federal assistance authorized by Executive Order.

Most Unemployment Benefits Are Taxed As Ordinary Income

For individuals receiving UI payments in 2020, it is important to understand the tax treatment of those benefits. Both state and federal unemployment benefits payments (including PUA) are generally taxed as ordinary income by the IRS. As is the case with most regular income sources, recipients of these benefits are required to make tax payments throughout the year.

One way that taxpayers can meet this payment requirement is to request that tax be withheld from their UI payments, which can be done in most states by filing Form W-4V with the state’s unemployment benefits office. If no tax is withheld from their UI payments, taxpayers may need to make estimated tax payments to avoid facing a large spring tax bill, which could include penalties and interest charges.

A tax professional can help UI payment recipients determine whether they need to make estimated tax payments, and how much to pay. In most cases, estimated taxes must be paid quarterly. The first two quarterly payments for 2020 were due on July 15, while the third-quarter payment was due on September 15. If an individual missed these deadlines, penalties can still be minimized by making one or more payments as soon as possible.

IRS Tool Helps UI Benefits Recipients Determine Correct Withholding Amount

Even if tax is withheld from UI benefits payments, the amount withheld may be incorrect if a person’s benefit amount differs from their salary while working. To avoid an unnecessary tax surprise next spring, taxpayers can use the IRS Withholding Estimator tool to calculate the appropriate withholding amount, and file an updated Form W-4V to request additional withholding, if applicable.

UI benefits recipients should also do a second checkup with the Withholding Estimator after returning to work, to ensure that their paycheck withholding is accurate going forward. Users of this tool will need detailed records of all their UI benefits payment amounts, as well as their earnings from employment (including self-employment) throughout the year.

UI Benefits May Affect the Amount of Affordable Care Act (ACA) Tax Credits

Unemployment compensation may have additional tax implications for those who purchased their health insurance plans through an insurance exchange or marketplace established under the Affordable Care Act (ACA). Many users of these plans have their premiums reduced each month by an amount known as the Advanced Premium Tax Credit (APTC).

Because becoming receiving UI benefits can significantly affect taxpayers’ total 2020 income, their eligibility to receive the APTC, and/or the amount of their tax credit, may be affected. Therefore, taxpayers who have an ACA health plan, and who have had a significant change in income due to receiving UI benefits, should report the income decrease or increase to the exchange where they purchased their plan as soon as possible. Having the APTC amount adjusted now can prevent an unpleasant spring tax surprise that might include penalties.

There is one important exception to the general rule that UI benefits are included in ACA eligibility calculations. The CARES Act specifies that the $600-per-week federal PUA bonus is not to be included when determining a taxpayer’s eligibility to receive health coverage under a state’s ACA Medicaid Expansion or Children’s Health Insurance Program (CHIP). However, eligibility may be impacted by other UI benefits payments, so recipients should still report any income changes to the state agency that administers their Medicaid or CHIP coverage.

Taxpayers who are uncertain whether their health care coverage is part of a state’s ACA Medicaid Expansion or CHIP programs can learn the name of their state’s programs by using the State Medicaid and CHIP Program Names tool at healthcare.gov.

Managing Income Fluctuations During a Challenging Year

Even if your overall employment status has not changed during 2020, you may still have experienced significant income fluctuations due to the far-reaching effects of the pandemic. It is a good idea for everyone to perform a withholding and estimated tax checkup as soon as possible to make sure your tax payments for 2020 are on track. You can also speak to your tax professional for help determining if any adjustments to your withholding or estimated payments are needed.

Posted on December 1, 2020