The COVID-19 pandemic has hit millions of Americans and upended life around the world. But there is one group that has been hit very hard – moms. Unexpected job losses, decisions to exit the workforce due to the increasing demands at home to be a homeschool teacher, or increased demands at work while maintaining the home have disproportionately impacted moms. Unemployment has become a lifeline for many during these turbulent times. But did you know that this lifeline now has the potential to be a major headache during tax time?
The reason is that unemployment benefits are considered income, similar to income earned at a job. Therefore, you must report unemployment benefits as income on your tax return. This means that you will owe federal, state, and even local taxes on that income. However, you will not be subject to payroll taxes which include Social Security and Medicare which are normally withheld from your paycheck.
When considering state taxes, it is important to understand that states vary in how they treat unemployment benefits. If you live in a state that doesn’t have a state income tax, then you do not have to pay state income taxes on your unemployment benefits. States without state income tax include Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Additionally, if you live in a state that doesn’t collect state income tax on unemployment benefits, then your benefits will not be taxable. These states include California, Montana, New Jersey, Pennsylvania, and Virginia.
So how do you avoid a surprise tax bill at tax time?
You can avoid a surprise at tax time by opting to have taxes withheld from your unemployment benefits when you apply for benefits or you can file an IRS Form W-4V, Voluntary Withholding with your state unemployment office. This will allow you to withhold 10% for federal taxes, which means that your weekly unemployment benefits will be reduced by 10%.
But even once you opt to have federal income taxes withheld from your unemployment benefits, there is still the question of state and local benefits. Check with your state’s unemployment office to see if you can have state taxes withheld from your benefits check. If you know that you live in a state and local community where you will owe income taxes on your benefits and you cannot have them withheld, then consider opening a separate fee-free savings account where you can save a percentage of your unemployment benefits to cover your state and local taxes. This will help you have the money on hand to cover any potential tax bills.
When deciding if and how much money to have withheld, consider how much in taxes you paid prior to becoming unemployed. During your time of employment, most likely your employer had been withholding federal, state, and local taxes which means you would have already been contributing towards your tax time bill. You can estimate your potential federal tax liability by using the IRS Tax Withholding Estimator. Check with your state to see if there is a similar estimator for your state. This is important because it helps you to understand if you need to withhold any federal taxes, and how much state and local taxes you should save up for.
Also, if you decide not to opt into the federal tax withholding, the tax estimator can help you to determine your tax bill which will allow you to make quarterly tax payments and avoid a massive tax bill at tax time.
What other considerations do you need to know?
I just discussed how to protect yourself from a potential tax time bill. However, there is something else that you need to consider. It’s one thing to protect yourself from a future tax bill, but what if you need the money now to cover your essentials like housing, food, and transportation?
If you are on a tight budget, your jobless benefits may not be enough to cover your basic needs and pay your quarterly taxes or reduce your benefits by 10% to cover withholding. If this is the case, then it is best to decide to skip the withholding and the savings strategy to pay for your needs instead. It is more important to have the money for your needs than to do without to prevent a future tax liability. Please note, that if you do this, you may encounter an underpayment of estimated tax penalty, but in certain cases then underpayment penalty may be waived. However, it is way better to have food, shelter, and basic needs.
The key is prioritizing the things that are most important. Also make sure you stay connected with God and pray for Him to continue to guide you, direct you, and give you peace. Know that tough times don’t last always and things will get better.
I hope that these tips have helped you understand how your tax bill could be impacted by unemployment benefits, that you are better prepared to plan for your taxes, and to have peace in whatever decision you make.
Aisha Taylor is a single mom of twins, personal financial coach, work from home entrepreneur, and #1 Amazon Best Selling Author of the book “5+5 FNPhenomenal Ways to Save $100 This Week Without Killing Your Lifestyle.” Aisha has been featured in ESSENCE, Jet Magazine, and Black Enterprise. She is also the Founder of FNPhenomenal (Frugal –n- Phenomenal), a movement designed to help single moms create a vision for their lives, craft a financial strategy to support that vision, and show them that phenomenal living is possible. It’s time for you to be Financially Phenomenal!