The Internal Revenue Service has been warning people that unemployment benefits are taxable at the federal level, but some people could still get hit with an unexpected tax bill when they file their Form 1040 next year.
State employment agencies, including the California Employment Development Department, give people the option of having 10% of their base unemployment payment withheld for federal taxes. But most people don’t, and even if they do, it might not be enough to cover what they actually owe if they have other income. California does not tax unemployment benefits, although some states do.
One problem this year is that even when people opted for withholding, EDD withheld nothing from the extra $600 per week that everyone on unemployment got from April through July, nor from the extra $300 added to benefits for six more weeks. Those extra federal benefits alone amounted to as much as $12,000.
Someone getting the maximum base benefit of $450 per week in California for nine months, plus the additional $12,000 in benefits, could have received almost $30,000 in unemployment.
The IRS expects people to pay tax on their income throughout the year, as it is earned, through withholding or by making estimated tax payments each quarter or both. Those who don’t pay enough of their total tax liability could face an underpayment penalty, if the shortfall is large enough.
The EDD does not track how many people request withholding, but attorneys who work with the unemployed say few do. The good news is, they may not need withholding if their income is low enough.
The standard deduction this year is $12,400 for singles and $24,800 for married couples filing jointly. So you would need to earn at least that much — from a job, unemployment and other sources combined — before you’d owe taxes. And you could earn even more, depending on what other deductions and credits you get.
Federal tax rates start at 10% of taxable income up to $9,875 (single) or $19,750 (joint filers).
That means a single person “is not going to pay much tax on their first $22,000 in income,” said Eva Rosenberg, an enrolled agent in Northridge (Los Angeles County)who runs the website TaxMama.com.
Various credits could reduce what you owe.
Parents, for example, get a credit of up to $2,000 for each child younger than 17. After calculating your tax, a credit reduces what you owe dollar for dollar. If it reduces your tax bill below zero, some of it could be refunded to you. (This is known as a refundable credit.) Taxpayers can get a credit up to $500 each for older dependents, although this credit is not refundable.
Low-income taxpayers may qualify for the earned income tax credit if they had some work during the year, especially if they have children. This credit is also refundable.
Generous unemployment benefits could make it harder for some people to get the earned income credit this year, said Elaine Maag, a researcher at the Urban Institute.
“Anecdotally, what I’m hearing is that people who work with low-income taxpayers are very concerned” that some on unemployment will get hit with a tax bill they can’t pay, Maag said.
Amy Spivey, director of the UC Hastings Low-Income Taxpayer Clinic, said, “I have reviewed many clients’ unemployment disbursements for qualifying for our services, and none of them have had taxes withheld, so I think it’s going to be a big problem next year.”
Some parents are also concerned about their unemployed children who will be filing tax returns for the first time. “They are saying you gotta put two of those unemployment insurance payments away now” for taxes, Maag said.
Another issue: “EDD has yet to address how they will handle fraudulent claims filed on behalf of real people. Those innocent people will probably be liable for the taxes on funds they didn’t need which were then spent by someone else,” said Alisha Gallon, a spokeswoman for Assemblyman Jim Patterson, R-Fresno.
Carol Jensen, who worked as a part-time instructor at three Bay Area community colleges, had nothing withheld from her unemployment. But that’s because she increased the amount withheld from her paychecks as soon as she realized her jobs would end after May. “I could see the writing on the wall. I changed my W-4 (payroll withholding form) very quickly. I had tons of money taken out. It was milk and Wheaties for a while,” she said.
Some people could find themselves owing a penalty if the balance due on their 2020 is large enough.
The “underpayment of estimated tax” penalty is actually interest on the tax you should have paid during the year, but didn’t. The good news is, it’s generally not huge, and it’s waived if you meet one of these exceptions:
• The amount you owe with your return is less than $1,000.
• The amount you paid for 2020, through withholding or estimated tax, is at least 90% of your total tax liability for 2020, or 100% of your 2019 tax liability. The latter is increased to 110% of last year’s tax if your 2019 income was $150,000 or more.
• The IRS also may waive the penalty if you missed a required payment because of a disaster or other unusual circumstance or if you retired (after age 62) or became disabled during the year. You can request a waiver on Form 2210.
“I asked the IRS to put in an exclusion from penalty for people who were on unemployment. I’m hoping they may do that,” Rosenberg said.
If you’re worried about a penalty, you could try to increase your withholding or your spouse’s, although there are not many pay periods left this year. You could also make an estimated tax payment by Jan. 15, the due date for the fourth quarter payment, which could defray a potential penalty.
You can estimate your tax using the IRS calculator at bit.ly/irsestimator.
Kathleen Pender is a San Francisco Chronicle columnist. Email: kpender@sfchronicle.com Twitter: @kathpender
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November 28, 2020 at 07:00PM
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Federal tax hit could take many unemployed people by surprise - San Francisco Chronicle
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