Do I Need to Pay Taxes on Unemployment?

Concerned woman completing her taxes.

If you collected unemployment benefits in 2021, you may be wondering if you have to pay taxes on the money you received. The short answer is yes.

That’s a big change from last year when you filed your 2021 tax return on 2020 income. For 2020 federal tax returns, the American Rescue Plan of 2021 allowed an exclusion of up to $10,200 per individual, but that tax break wasn’t extended for 2021.

As the April 15 income tax filing deadline approaches, you need to be prepared to pay federal taxes on unemployment compensation you collected in 2021. You could be hit with some sticker shock. Here’s what to know.

Why Unemployment Benefits Are Taxable

Unemployment benefits are treated like regular income. Your benefits get reported to the IRS and are subject to federal income tax. The amount you received during the year gets added to your overall taxable income. Although the benefits aren’t specifically taxed (nothing is withheld unless you opt in), it’s that total amount of income that shapes your tax bill.

Most states with a state income tax also collect taxes on unemployment benefits, but some do not. Check the table at the end of this article to see if your state taxes unemployment benefits and what the rate is. You can find more details about each state’s approach in this guide.

The main difference between unemployment and regular wage income is that you don’t pay Social Security or Medicare taxes on unemployment benefits (listed as FICA taxes). Also, the percentage you pay on your benefits is determined by your income bracket. For example, if you’re a single filer and you earned between $9,951 and $40,525, you fall in the 12% federal tax bracket for 2021-2022.

How to Handle a Tax Bill if You’re Still Unemployed

You may be feeling the financial pinch if you’re still unemployed. If you can’t afford to pay your tax bill, the IRS offers a few options.

First, contact the IRS right away to explain your situation and find out if you’re eligible for an alternative payment plan. They can discuss your options with you and set you up on a repayment plan, such as a short-term repayment plan within 180 days or a long-term installment plan over 72 months. It’s peak tax season right now, so it may not be easy to get through right away. Try to be patient.

If you’re not able to pay anything at all, the IRS may decide your account is “currently not collectible.” That designation temporarily delays their collection process.

Keep in mind, your tax debt doesn’t go away. Penalties and interest may accrue on the unpaid amount during this “not collectible” period. You’ll also be expected to pay fees and interest on any installment plan as well. Going forward, if you can afford to pay a little bit toward next year’s tax bill, that’s advisable to avoid a lump sum in April.

How to Avoid a Hefty Tax Bill on Unemployment Benefits

To avoid being socked with a large bill come tax time, you can voluntarily choose to withhold a portion from your unemployment benefits so you don’t get stuck with a tax bill or lose out on a refund you were expecting.

Unless you absolutely can’t manage to pay throughout the year, it’s highly recommended you opt in to withholding a certain amount. The agency that pays your unemployment benefits will withhold a flat 10% to cover all or a portion of your tax bill.

Once you’ve returned to work, it’s worth making sure you have the correct amount withheld to avoid a surprise bill. Use the IRS tax withholding calculator to see how much you should withhold.

What Else to Know About Unemployment Tax Withholding

Even though the IRS recommends you withhold a certain amount from your unemployment benefits to cover taxes, your wellbeing comes first. Of course, avoiding a big tax bill is preferable, but if money is extra tight, it’s more important to pay your utility bills and keep food in your pantry. You can always work out a way to repay your bill with the IRS later. Better that than letting your fridge go unstocked.

Are you still unemployed? Take a look at our unemployment resource. We are here to help. If you’re back to work but dealing with a hefty tax debt because of your time away from work, talk to an MMI credit counselor. We may be able to help you address your other debts and bring some balance to your budget.

Chart: States that tax your unemployment benefits

State Taxes unemployment benefits? If so, how much?
Alabama No  
Alaska No  
Arizona Yes   Same guidelines as federal
Arkansas Yes AK has made an exemption for 2020 and 2021 tax years; income tax range is 2% to 5.5% depending on income
California No  
Colorado Yes Flat income tax rate of 4.5% for 2021, 4.55% in 2022
Connecticut Yes Same guidelines as federal
Delaware Yes DE has made an exemption for 2020 and 2021 tax years; income tax range is 2.2% to 6.6% depending on income
DC No  
Florida No  
Georgia Yes Same guidelines as federal
Hawaii Yes Income tax range is 1.4% to 11%
Idaho Yes Same guidelines as federal
Illinois Yes Flat income tax rate of 4.95%
Indiana Yes Flat income tax rate of 3.23%; some unemployment benefits may also be tax deductible
Iowa Yes Income tax range is 0.33% to 8.53% depending on income
Kansas Yes Same guidelines as federal
Kentucky Yes Flat income tax rate of 5%
Louisiana Yes Same guidelines as federal
Maine Yes Income tax range is 5.8% to 7.15%
Maryland Yes Same guidelines as federal; 2020 and 2021 tax year exemptions for those with gross adjusted income at or below $75,000 (single) or $100,000 (married filing jointly)
Massachusetts Yes Flat income tax rate of 5%; 2020 and 2021 exemptions for up to $10,200 of unemployment benefits if household income is below 200% of federal poverty level
Michigan Yes Flat state income tax is 4.25%
Minnesota Yes Income tax range 5.35% to 9.85%
Mississippi Yes Income tax range is 3% to 5%
Missouri Yes Same guidelines as federal
Montana No Unemployment benefits will be taxed beginning in 2024
Nebraska Yes Same guidelines as federal
Nevada No  
New Hampshire No  
New Jersey No  
New Mexico Yes Same guidelines as federal
New York Yes Same guidelines as federal
North Carolina Yes Flat state income tax rate of 5.25%; drops to 4.99% in 2022 and continues to drop each year until it reaches 3.99% in 2027
North Dakota Yes Same guidelines as federal
Ohio Yes Same guidelines as federal
Oklahoma Yes Same guidelines as federal
Oregon Yes Income tax range is 4.75% to 9.9%
Pennsylvania No  
Rhode Island Yes Income tax range is 3.75% to 5.99%
South Carolina Yes Same guidelines as federal
South Dakota No  
Tennessee No  
Texas No  
Utah Yes Same guidelines as federal
Vermont Yes Income tax range is 3.35% to 8.75%
Virginia No  
Washington No  
West Virginia Yes Same guidelines as federal
Wisconsin Yes Income tax range is 3.54% to 7.65%; a portion of unemployment benefits may be exempt
Wyoming No  

Tagged in Taxes, Managing a loss of income

Jesse Campbell is the Content Manager at MMI, focused on creating and delivering valuable educational materials that help families through everyday and extraordinary financial challenges.

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