Does Unemployment Count As Income And Is It Taxed?

When facing financial difficulties, you still have to pay the bills, which can be quite stressful. Thankfully, government programs such as unemployment compensation are there to help see people through tough times, which can include struggling to afford the basic necessities.

If you’re experiencing financial hardship due to a job loss, collecting unemployment income as a temporary solution can be helpful as you look for another job.

However, if you’ve been receiving unemployment assistance, you may be wondering if it counts as income. The short answer is yes – and it may affect your taxes.

How Unemployment Affects Your Taxes

If you received unemployment income during 2021, the amount counts toward your taxable income, according to the IRS. This is different from the 2020 tax year, when the American Rescue Plan Act (ARPA) waived up to $10,200 of unemployment income, giving job seekers a tax break.

In other words, for the 2021 tax year, all the money you received from unemployment assistance — whether it's the federal or state government — counts as taxable income. It could mean you’ll end up owing when you file your income tax return, but it depends on factors such as any other income you receive and filing status — check with a tax professional to help with your individual situation.

Is Unemployment Considered Income?

When you earn a paycheck as an employee, part of your gross income automatically gets deducted to pay for federal and Social Security taxes. This means any form of income — even if it’s from the government, with few exceptions — needs to be taxed.

Unlike income from an employer, these taxes aren’t automatically deducted from your unemployment benefits. Since you’re still responsible for paying your taxes, it needs to be counted toward your gross income. Although unemployment income counts as ordinary income, they are not subject to Social Security and Medicare taxes. Depending on where you live, you may also be required to pay state income taxes on unemployment income.

If you’ve received unemployment benefits, you should receive Form 1099-G during tax season. This form will include information such as your personal details, unemployment income received, and whether there were any state or federal taxes withheld.

What Qualifies As An Unemployment Benefit?

Unemployment benefits are income you receive directly from the federal or state government. You can apply for it through your state’s unemployment office.

Federal And State Taxes On Unemployment Compensation

Those who received unemployment benefits have several options for how to pay state and federal taxes, including having it withheld from each payment or paying the full amount during tax season.

Unemployment Benefits And Federal Income Tax

You can choose to set up tax withholding for your unemployment compensation payments much like you would with a paycheck from an employer. That way, you may be able to avoid any surprises when you file your income taxes.

If you do decide to withhold federal income taxes, you can request to have them withheld from each payment when applying for unemployment benefits. Otherwise, you can file Form W-4V (Voluntary Withholding) through your state’s unemployment office. Keep in mind you can only withhold up to 10% of each payment for federal income taxes.

Another option is to pay quarterly estimated taxes. This allows for some flexibility in how often you pay, giving you a longer time to pay when compared to the weekly frequency with which you receive unemployment income.

Unemployment Benefits And State Income Tax

Many states will tax your unemployment benefits, though the nine states that don’t have a state income tax most likely won’t.

If you live in the following states that do have a state income tax, your unemployment benefits aren’t taxable:

• California
• Montana
• New Jersey
• Pennsylvania
• Virginia

Alabama, Indiana and Wisconsin may not tax some of your unemployment benefits, but that’s not always the case. Each state has its own rules that are subject to change, so it’s best to check with your state’s unemployment office to determine your tax liabilities.

The Bottom Line: Unemployment Counts As Income And Is Taxable

When paying taxes on your unemployment income, it’s your choice whether you want to pay taxes each time you get paid, pay them quarterly or when you file your annual income taxes. There’s no right or wrong answer, and your decision will likely depend on which schedule works best for your financial situation.

It may make sense not to have taxes withheld weekly if you’re struggling to make ends meet. However, if you can afford having taxes withheld each week and are worried about owing Uncle Sam later, it might make sense to just pay the taxes as you go.

If you didn’t make tax payments on your unemployment benefits throughout the year, you might have a large bill when tax season arrives. If you do, and you need assistance paying, check out the Rocket Money^SM Personal Finance page for information and advice on how to file your taxes.