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Is Unemployment Compensation Subject To Income Taxation?

by | Apr 28, 2020 | COVID-19, Federal Taxation |


The novel coronavirus crisis has had an unprecedented effect on the world economy.  On March 11, 2020, the World Health Organization declared that the COVID-19 outbreak was officially a pandemic as rates of infection rose significantly is the U.S. and across the world.  On March 13, 2020, President Donald Trump declared a national emergency in the United States.  Many states followed suit and issued a number of executive orders that closed down non-essential businesses, restricted travel and compelled many residents to stay in their home until the emergency passes.  With many businesses having to shut down and lay off workers, there has been an unprecedented number of individuals filing for unemployment benefits in their respective states.  In Michigan, an individual can receive up to $394.00 per week in unemployment compensation.  In addition, the the Coronavirus Aid, Relief And Economic Security (CARES) Act provides additional “federal pandemic unemployment compensation” up to $600.00 per week.  CARES §2104((b)(1)(B).  Many people applying now have likely never been initiated into filing for benefits before, so there is likely many questions they have about the compensation received.  One major question: are my unemployment compensation payments taxable?

U.S. taxpayers are generally required to pay federal income taxes on all gross income.  “In the case of an individual, gross income includes unemployment compensation.”  26 U.S.C. §85(a).  “Unemployment compensation” means “any amount received under a law of the United States or of a State which is in the nature of unemployment compensation.”  26 U.S.C. §85(b).   Unemployment compensation is paid at ordinary gains rates, meaning that you are paying the same income taxes as you would if the benefits were received as salary or wages.  However, unemployment compensation is not subject to Social Security taxes or Medicare taxes (usually 7.65% of your income).  The amount of compensation paid and the taxes due will appear on Form 1099-G issued by the government agency disbursing the benefits.

Keep in mind that unemployment compensation is not considered “earned income” for purposes of the earned income tax credit (EITC).  The EITC requires that you have some earned income during the tax year from salary, wages, self-employment income or other compensation from services performed to be eligible for this refundable tax credit.  If you have ONLY received unemployment compensation during the tax year, you will not qualify for this valuable tax break.

The State of Michigan also taxes unemployment compensation benefits at a flat tax rate of 4.25%.  Recipients will receive Form 1099-G from the Michigan Unemployment Insurance Agency and a copy will also be furnished to the Internal Revenue Service and the Michigan Department of Treasury.  Recipients may also elect to have taxes withheld from their unemployment compensation to cover federal and state liabilities so that a nasty surprise debt is avoided on Tax Day.

There are two other types of “unemployment” benefits you should be aware of:

  • Supplemental Employment Benefits (SUBs) – These refer to benefits paid by a company financed fund to provide additional income to terminated or laid-off employees in addition to the state unemployment benefits. These benefits usually arise out of collective bargaining agreements between the company and the union.  These benefits are fully taxable as wages and will appear on the employee’s Form W-2.
  • Unemployment Benefits From Private Fund – Employees may voluntarily contribute either to a common pool fund or an individual account in which they may receive payments from if they become unemployed. Despite the label, these payments are not considered “unemployment compensation” under the Internal Revenue Code, for 26 U.S.C. §85(b) requires that “unemployment compensation” comes from a government entity.  The taxable portion of these private fund payments are those amounts that are more than the total payments that you made into the fund.  If your benefits did not exceed your total payments, then they are not taxable.  These payments are reported as “Other Income” on Form 1040 of your individual tax return.

If you do not elect to have federal or state taxes on your unemployment compensation withheld, then you may be liable to make quarterly estimated tax payments to the IRS and the State of Michigan.  Failure to comply with estimated tax payments if required by law can result in penalties and interest being assessed.   A tax lawyer can advise you of your responsibilities and ensure that you are compliant with both federal and state tax laws.  If you have questions about unemployment compensation, do not hesitate to contact the experienced attorneys at Kershaw, Vititoe & Jedinak PLC for assistance today.


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