Did You Receive Unemployment Compensation in 2020? Read This Now!

• Author: Monica Jackson
• Posted: 2024-06-23

Due to the COVID-19 pandemic, millions of Americans received unemployment compensation as their jobs disappeared overnight. For many this acted and perhaps even still continues to act as a lifeline. As soon as the CARES Act's provision that paid an additional $600 per week to every unemployment applicant, many were left with very little benefits.

As a result, the only unemployment money after July 31, 2020, that Americans have been able to receive is whatever their state's unemployment insurance maximum is, so long as their two top-performing quarters of the previous year are equal to or greater than that. However, even this small boost will expire the day after Christmas.

Tax Season Is Approaching

While the Department of the Treasury will undoubtedly delay the deadline for filing federal income tax, your state may not. Unfortunately, while the $1,200 single stimulus was not taxable, any unemployment compensation you might have received and the attached $600 bonus are taxable!

A few states already withhold this money. If you see on your unemployment portal that your state has been withholding your taxes for you, good job! That means that you won't have to take any further action. Regardless, you should calculate your own taxes to assess how able you are to pay any remaining ones.

What If I Can't Pay the Tax?

For unemployment money, you will owe solely income tax. This means that you're off the hook for FICA taxes. These taxes cover your Social Security and Medicare for the future. Unemployment income tax is just put on top of your other income and into the federal bracket system just as though it were earned income.

If you're already barely making it, and you know that there's no way that you can pay your unemployment income taxes to both your state and the federal government, now is the time to get on it!

Generally, the IRS is much easier-going on people who voluntarily admit that they will not be paying their taxes on time. You will likely be offered a payment plan. Depending on whether this has happened before and some personal factors, this plan will likely be at zero or very little interest.

How Do I Offset This Tax?

Let's say you earned $8,000, and then the pandemic struck. Let's also say that your taxable unemployment income was $14,0000. Because you earned $8,000, you're eligible to contribute up to the IRS maximum to an IRA of $6,000 in most cases. An IRA is essentially a 401(k) for individuals not associated with a specific workplace.

Because an IRA is tax-deferred, you don't actually pay income on the proceeds now. You pay income tax when you withdraw from your IRA. Roughly estimating the 2020 personal deduction at $13,000, your total federally taxable income in this example scenario would be your earned $8,000 and your "unearned income" per the IRS of $14,000 adding up to $22,000. When we subtract $13,000, we're left with $9,000 of federally taxable income.

Even at the very lowest bracket, you'll be paying 10% federally on that unemployment money. In this case, that would mean you'd owe the federal government $900!

Performing the Offset

In most cases, the "Saver's Credit" offered by the IRS can make a huge difference in how much you're taxed. Though the guidelines differ each year, the rules remain the same. There are three tiers. The first is usually capped at around an Adjusted Gross Income (AGI) of $20,000. This means that you have $20,000 remaining after these IRA contributions. The second bracket is usually between around $20,000 and $22,000. The third is usually between roughly $22,000 and $32,000.

The most money that can count towards the Saver's Credit is a $2,000 contribution. If you're in the first tier, you can get 50% of that back in the form of a credit towards your taxes. That means that you can both lower your AGI and get a $1,000 credit towards your taxes. The second bracket only gives you a credit worth 20% of your contribution up to $2,000; the final only allows for 10% of your contribution up to $2,000.

Keep in mind that these are non-refundable credits; that means that you won't ever get money back from them if you didn't owe that amount of income tax. Happy savings!