The IRS is advising millions of Americans receiving unemployment benefits, including many for the first time, that those benefits are taxable.

People receiving unemployment should “have tax withheld from their benefits now to help avoid owing taxes on this income when they file their federal income tax return next year,” the agency said in a statement.

“By law, unemployment compensation is taxable and must be reported on a 2020 federal income tax return,” the IRS said.

The IRS said taxable benefits include any of the special unemployment compensation authorized under the federal CARES Act.

Connecticut recently issued its own guidance to help businesses and individuals that received assistance through the CARES Act determine its impact on their state taxes.

Withholding

The IRS said withholding is voluntary and that federal law allows anyone receiving unemployment benefits to have a flat 10% withheld to cover all or part of their tax liability.

This is done by filling out IRS form W-4V and giving it to the agency paying the benefits—in Connecticut, the state Department of Labor, but check first with your employer or the DOL website.

Instead of having 10% of benefits withheld, especially if it’s not enough, taxpayers can make estimated quarterly payments.

The payments for the first two quarters of 2020 were due July 15 while third quarter payments are due Sept. 15, and fourth quarter on Jan 15, 2021.

For more information and helpful worksheets, see IRS form 1040-ES and IRS publication 505.

Checklist

Some of the the types of payments taxpayers should check on their withholding include:

  • Unemployment compensation benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund
  • Railroad unemployment compensation benefits
  • Disability benefits paid as a substitute for unemployment compensation
  • Trade readjustment allowances under the Trade Act of 1974
  • Unemployment assistance under the Disaster Relief and Emergency Assistance Act of 1974
  • Unemployment assistance under the Airline Deregulation Act of 1978 program

Filing

Unemployment recipients who return to work before the end of the year can use the IRS tax withholding estimator to make sure they are having enough tax taken out of their pay.

Then in January 2021, unemployment benefit recipients should receive a form 1099-G, which will show the amount of unemployment compensation they received during 2020 in Box 1, and any federal income tax withheld in Box 4.

Taxpayers report this information, along with their W-2 income, on their 2020 federal tax return. 

For more information on unemployment, see unemployment benefits in IRS publication 525.