If you received unemployment benefits last year and filed your 2020 tax return relatively early, you may find a check in your mailbox soon (or a deposit in your bank account). Starting in mid-May, and extending through the summer, the IRS will automatically issue tax refunds to those Americans who filed their 2020 return and reported unemployment compensation before tax law changes were made by the American Rescue Plan.
Signed on March 11, the American Rescue Plan exempts from federal tax up to $10,200 of unemployment benefits received in 2020 ($20,400 for married couples filing jointly) for households reporting an adjusted gross income (AGI) less than $150,000. The IRS has identified over 10 million people who filed their tax returns before the plan became law and is reviewing those returns to determine the correct amount of tax on their unemployment compensation. For those affected, this could result in a refund, a reduced tax bill, or no change at all. (You can use the IRS’s Interactive Tax Assistant tool to see if payments you received for being unemployed are taxable.)
The IRS will recalculate impacted tax returns in two phases. First, it will start with returns for single taxpayers who had the simplest tax returns, such as those filed by people who didn’t claim children as dependents or any refundable tax credits. It will then adjust returns for married couples filing jointly who are eligible for an exemption up to $20,400 and others with more complex returns.
The new tax exemption only applies to unemployment benefits received in 2020. So, if you receive unemployment compensation in 2021 or beyond, expect to pay federal tax on the amount you get.
As for state taxes, just because the federal government is waiving taxes on the first $10,200 of your 2020 unemployment benefits, that doesn’t mean your state will too. To see if your state has adopted the federal exemption for 2020 state tax returns, see Taxes on Unemployment Benefits: A State-by-State Guide.
Refunds for Unemployment Compensation
If you’re entitled to a refund, the IRS will directly deposit it into your bank account if you provided the necessary bank account information on your 2020 tax return. If valid bank account information is not available, the IRS will mail a paper check to your address of record. The IRS says it will continue to send refunds until all identified tax returns have been reviewed and adjusted.
The IRS will send you a notice explaining any corrections. Expect the notice within 30 days of when the correction is made. Keep any notices you receive for your records, and make sure you review your return after receiving an IRS notice.
The refunds are also subject to normal offset rules. So, the amount you get could be reduced (potentially to zero) if you owe federal tax, state income tax, state unemployment compensation debt, child support, spousal support, or certain federal non-tax debt (i.e., student loans). The IRS will send a separate notice to you if your refund is offset to pay any unpaid debts.
Should I File an Amended Return?
Although the IRS says there’s no need to file an amended return, some early filers may still need to, especially if their recalculated AGI makes them eligible for additional federal credits and deductions not already included on their original tax return.
The IRS, for example, can adjust returns for those taxpayers who claimed the earned income tax credit and, because the exemption changed their income level, may now be eligible for an increase in the tax credit amount which may result in a larger refund. That said, taxpayers will need to file an amended return if they didn’t originally claim the tax credit, or other credits, but now are eligible because the exclusion changed their income, the IRS said. These taxpayers may want to review their state tax returns as well.
Withholding from Unemployment Compensation
Again, the $10,200 exemption only applies to unemployment compensation received in 2020. So, to avoid a big tax bill when you file your 2021 return next year, consider having taxes withheld from any unemployment payments you receive this year.
Contact your state unemployment office to have federal income taxes withheld from your unemployment benefits. You may be able to use Form W-4V to voluntarily have federal income taxes withheld from your payments. However, check with your state to see if it has its own form. If so, use the state form instead.
Excess Premium Tax Credit Payments
The American Rescue Plan also suspends the requirement to repay excess advance payments of the premium tax credit. If you repaid any excess credit when you filed your 2020 return, the IRS is also refunding this amount automatically. If the IRS corrects your return to reflect the unemployment compensation exclusion, any excess premium tax credit amount you paid will be included in the adjustment. The IRS is also adjusting returns for people who repaid excess premium tax credits but didn’t report unemployment compensation on their 2020 tax return.