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Do you pay taxes on unemployment benefits? Here's what you need to know

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If you are dealing with a job loss and are currently receiving unemployment benefits, there are a couple of steps you can take to make sure you aren't hit with an unexpectedly large bill from the IRS when tax season rolls around next year. 

That's because, though it may come as a surprise, in many cases unemployment benefits are taxable. "The IRS looks at this money as deferred compensation," says William Dickens, a university distinguished professor of economics at Northeastern University.

Depending on where you live, you may need to pay state or local taxes on your unemployment benefits on top of paying federal taxes on them. At the federal level, unemployment is taxed as ordinary income; but state by state, tax rates vary, as does whether unemployment benefits are viewed as income.

"It gets complicated because some states don't tax, some tax the full amount, then other states exempt certain fractions," says Dickens. States like Florida and Texas, for example, don't impose any state income taxes. Meanwhile, unemployment benefits are tax exempt in New Jersey, California, and a handful of other states. 

The good news is that, in general, getting square with the IRS is relatively simple. Here are some tips to help.

Monitor your withholding 

Just as employees have taxes automatically withheld from a paycheck from an employer, you can opt to do the same with your unemployment benefits. To set that in motion, you have to submit IRS form W-4V to make a voluntary withholding request of your federal income taxes.

This form is separate from your application for unemployment benefits. You can submit it through your state's unemployment insurance program. 

Just keep in mind that every state is different, so be sure to connect with your local unemployment office to make sure you aren't overlooking any requirements.

With the W-4V, you're only able to withhold 10% of your earnings for taxes. No more, no less. In order to cease this withholding option, you'll have to submit a new W-4V form.

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Pay as you go

If you're already a freelancer or another type of self-employed worker, you may be used to paying estimated quarterly taxes to the IRS. You can do the same for your unemployment benefits. This is another way to mitigate the risk of having to pay one big bill in the spring when you file your taxes.

There are four payment deadlines, and you can make payments online. You can also use this IRS tax withholding estimator to figure out how much you'll need to pay.

Typically with estimated quarterly taxes, you would pay in April, June, September, and January. But this year, estimated tax payments that would have been due on April 15 and June 15 are now due July 15, 2020. 

Other tax tips

However, if you don't want to use the W-4V form or pay estimated taxes quarterly, another option is to set a portion of each unemployment check aside for taxes in a dedicated savings account, either manually or automatically, so the money is there waiting for you when it's time to settle up with the IRS. 

When you file your taxes in April 2021, you'll also need your 1099-G form, which will show your total unemployment compensation payments for the year. You will need to include this number in your total income when filing your tax return. Make sure check with your unemployment office whether you can simply access the 1099-G electronically through your online portal, if you'll automatically receive a copy in the mail, or if you need to request a paper copy.

Taking these steps can give you a measure of control now and help avoid any big surprises next year.

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How to apply for unemployment benefits

Before you worry about how your benefits will be taxed, you have to successfully start claiming them. Forty million people have filed for unemployment benefits since the start of the pandemic. Here are some Grow resources to help you navigate the process.

  1. How to file for unemployment benefits if you lose your job because of the coronavirus. Learn materials you'll need to apply for unemployment and what makes you eligible for benefits.
  2. How to apply for unemployment as a freelancer. Learn what aid packages are available on the state and federal level and how to prepare your paperwork. 
  3. Layoffs vs. furloughs: The important differences workers need to know. Learn how either status informs your job search, either for full or part-time work, if you can file for unemployment, and what happens to benefits like health insurance. 
  4. How to reinvent yourself during unemployment. Business leaders Barbara Corcoran and Grant Sabatier share their best advice for how to utilize your skills and prepare yourself for the economic recovery.
  5. 'There are lots of jobs available': Why some experts are optimistic despite the April jobs report. As of May 8, the top 100 employers in the U.S. were hiring for more than 650,000 jobs.

Marianne Hayes is a freelance writer and content marketing specialist. She covers everything from personal finance to spiritual growth. Her work has been published in MagnifyMoney, Cosmopolitan, Redbook, Good Housekeeping, and Forbes. In addition to writing, she teaches local storytelling workshops in Tampa and is a hopeless bookworm.

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