Congress wants to give up unemployment taxes. Some states may not

Congress may soon offer a tax credit to unemployed Americans. States may not be so generous.

The Senate on Saturday passed a $ 1.9 trillion Covid relief bill that waives the tax of up to $ 10,200 in unemployment benefits per person received in 2020

President Joe Biden is expected to sign the legislation this week after it is passed by the Democratic-led House of Representatives.

But the tax policy, which applies to households that earned less than $ 150,000, only means a break in federal income taxes on workers.

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More than half of the states charge an income tax on unemployment benefits. If Congress waives the federal income tax, states must decide whether to offer the break as well.

Some may still choose to tax unemployment benefits, experts said.

As an example: Suppose a worker made $ 10,000 in benefits last year. That person would still pay a $ 500 tax bill in states with a 5% income tax (if we assume a fixed tax rate).

“It’s complex,” said Jared Walczak, vice president of state projects at the Tax Foundation. “Even many state officials are probably not sure what will happen next.”

Federal policy aims to avoid a surprise tax bill for the unemployed.

Some 40 million people received unemployment benefits last year and the average person received $ 14,000 in aid, according to a Century Foundation report.

However, less than half of the recipients had withheld taxes, according to the report. In some cases, states did not offer the option.

But the relief bill now changes the rules in the middle of the fiscal season, which began on February 12 and ends on April 15.

This has created confusion for taxpayers, accountants and policymakers.

Thirty-five states and the District of Columbia typically tax unemployment benefits as income, according to Walczak.

Three states (Maryland, Arkansas, and Delaware) usually do so, but waived the income tax received in 2020.

The rest of the states do not tax unemployment benefits, because they have no income taxes or exempt unemployment compensation.

State legislators must decide how to proceed and their decision is time-sensitive. Many laid off workers may be waiting to file their taxes until there is more clarity.

There is a political precedent for the waiver of unemployment income tax. In 2009, during the Great Recession, Congress exempted the first $ 2,400 in unemployment benefits from the tax, and many states followed suit, Walczak said.

However, this rule change did not occur during the fiscal season, he said.

Many state legislatures may have difficulty adopting the change, as they have already incorporated tax revenue into budget estimates for the current fiscal year, said Verenda Smith, deputy director of the Federation of Tax Administrators, who works with tax officials state.

States may need to draw money from other budget areas such as education to compensate, he said.

“It’s not easy to follow that,” Smith said. “It’s a tough budget decision for them.”

However, it would not be surprising for many states to finally adopt federal fiscal policy, given the level of financial pain among Americans, he added.

More than 18 million people continue to receive unemployment benefits, according to data from the Department of Labor.

“In something like this, it pulls the strings of people’s hearts,” Smith said. “It would be very difficult for an elected official to vote against such a thing.

“This is just political reality,” he added.

Taxpayers who received unemployment benefits last year and already filed their tax return are likely to have to file an amended return in the future.

But they should wait to do so until the U.S. bailout plan becomes law and there is more clarity on the part of the IRS, the Treasury Department and the respective states, experts said.

The IRS allows up to three years after the original filing date to submit a modified return and claim a refund.

Workers who have not yet filed a return should consider requesting an extension of the deadline for filing, according to experts.

If you do, you are not exempt from paying taxes before the April 15 tax deadline. They have to love and pay the taxes they owe to avoid penalties.

But it allows for extra time to see what state and federal lawmakers decide to do.

If the waiver of unemployment tax becomes law, those applying for an extension can omit unemployment benefits from their income (up to $ 10,200) when their 2020 federal tax obligation is estimated, according to Walczak.

But in states that assess unemployment income tax and have not yet offered guidance on new federal rules, workers should not deduct benefits when estimating state tax, if they want to be conservative, he added.