Stimulus Updates and Resources

IRS: More people can take advantage of the $10,200 unemployment tax break

"The IRS will send any refund amount directly to you."

The Internal Revenue Services offices in Washington, D.C.
Adam Jeffery | CNBC

More Americans who received unemployment benefits last year can take advantage of a tax break on up to $10,200 in income, according to IRS guidance released Tuesday.

The American Rescue Plan waives federal tax on unemployment benefits worth up to $10,200 for the year 2020. For married couples filing jointly, each spouse can exclude $10,200 of their benefits. The exemption only applies to tax filers who made less than $150,000 last year, whether they are filing as single or married.

The IRS specified Tuesday that taxpayers can exclude any unemployment benefits received when calculating their modified adjusted gross income, making more people eligible for the tax break. And if you've already filed your taxes without taking advantage of the unemployment tax break, the tax agency will issue you an automatic refund.

Whether you've already filed, or you're preparing your 2020 tax return, here's how to take advantage of the unemployment tax break.

Unemployment income doesn't count towards your AGI

About 40 million Americans collected unemployment insurance benefits last year, according to an analysis by The Century Foundation. Now that unemployment income doesn't count towards your modified adjusted gross income (AGI), more taxpayers will be able to take advantage of the retroactive $10,200 tax break.

Before the tax agency issued that guidance, a hypothetical couple filing jointly who earned $130,000 in 2020 and received a combined $20,400 ($10,200 per person) worth of unemployment benefits would not have been eligible for the tax break. Their joint income of $150,400 (including their jobless aid) would have meant they earned too much to qualify.

Under the new IRS guidance, this couple would not have to include their jobless aid in their income calculations. That means that their $130,000 joint income would allow each partner to take advantage of the $10,200 federal unemployment tax break.

The average unemployment beneficiary received a total of about $14,000 in unemployment benefits last year, according to The Century Foundation. Since the tax break included in President Joe Biden's relief plan only counts towards the first $10,200 of jobless aid, any remaining portion of the benefit would still be subject to federal taxes.

If you filed taxes early, the IRS will refund you

If you filed your 2020 taxes before the American Rescue Plan was signed into law and didn't take advantage of the unemployment tax break, the IRS says not to amend your return. "The IRS will refigure your taxes using the excluded unemployment compensation amount and adjust your account accordingly. The IRS will send any refund amount directly to you," the tax agency wrote Wednesday.

Those refunds, however, are unlikely to show up quickly. They will take time to process, says Janet Holtzblatt, senior fellow at the Urban-Brookings Tax Policy Center.

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"The IRS has not explained how they will be able to generate the automatic refunds, but I suspect that they are choosing among several options for making that happen," Holtzblatt says. "Each option, however, probably involves a trade-off between the speed with which those refunds can be paid and the potential for erroneous refunds."

If the IRS is calculating your refund, make sure to double check that you're getting the right amount, says Howard Samuels, a certified public accountant at Samuels & Associates in Florham Park, New Jersey. "People might need to kind of redo their taxes, factoring in the exclusion for unemployment, to come to the revised amount. Then compare to their refund to make sure it's correct. If not, then they might be able to call the IRS, but there's probably long hold times. Or then file an amended return to claim the difference."

In order to account for the changes in tax law that were issued in the middle of the 2020 tax season, the IRS has delayed the federal tax filing deadline until mid-May, giving taxpayers until May 17 to file and pay federal taxes.

TurboTax and H&R Block updated software for new tax break

If you have yet to file your taxes, you can now prepare them including the unemployment tax break. TurboTax and H&R Block have updated their online software to account for it, according to company officials.

H&R Block was able to process returns beginning Friday for people eligible for the federal tax waiver, a company spokeswoman told CNBC. While TurboTax has updated its online software, it plans to issue an update for its desktop software on Friday, a spokeswoman told CNBC.

States may not follow federal tax changes

The American Rescue Plan's $10,200 tax break on jobless aid only applies to federal income tax. Depending on where you live, you may also need to pay state or local taxes on your unemployment benefits. At the federal level, unemployment is normally taxed as ordinary income, but state by state, tax rates vary, as does whether unemployment benefits are viewed as income.

Many states that currently tax unemployment benefits have yet to decide whether they will allow those state taxes to be waived as well. Likewise, a handful of states haven't followed the federal government's lead and are still expecting taxpayers to file state taxes by April 15.

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