Have you been laid off or furloughed during the Covid-19 pandemic? With millions of Americans being laid off each week, many people are relying on unemployment benefits. While these are a lifeline during an economic or financial crisis, such benefits will also affect your income taxes in the spring. How? Here are the most important ways they will affect you and how to manage them to avoid a tax bill bite.
Unemployment and Taxable Income
Most public unemployment benefits are paid from taxes that your employer pays into. This means that when you receive the benefits, they will likely be taxable to you as regular income. If the benefits are lower than your normal salary — as is usually the case — your overall taxable income might be lower for the year. This is good because it means lower taxes. Lower annual income may also help if you receive a federal subsidy to pay for health insurance through the individual marketplace.
Keep in mind, though, that legislation in 2020 has also freed up some unemployed persons to receive up to $600 extra per week during the Covid-19 crisis. This could actually increase your annual taxable income. If this happens, your taxes could wind up being higher at the end of the year.
Unemployment and Withholding
Most Americans pay their income tax through voluntary withholding of a percentage of each paycheck. This is beneficial as it means fewer people have to write a check to the IRS or state agencies when filing their returns. But when you receive taxable income from other sources — such as unemployment benefits — you'll need to select an amount to be withheld from these checks to cover the tax.
The choice to have withholding taken from unemployment checks can be hard, as most people need this money when they're unemployed. But when the withholding is insufficient or nonexistent, it will generally result in either an amount due on April 15 or a smaller refund.
Unemployment and Tax Preparation
Finally, receiving income from an unusual source, like unemployment benefits, also makes your tax return a bit more complicated. This income must be reported correctly in order to avoid problems with the IRS.
Because many workers' experience with reporting unemployment on taxes is limited, you should work with an experienced tax preparation service. Along with completing forms correctly, they can help you plan for the tax impacts and minimize any potential problems. Learn more by making an appointment for a tax consultation today.
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