Millions of Americans have lost their paychecks over the past few weeks as the COVID-19 crisis has turned the U.S. economy on its head. Things have gotten so bad that lawmakers pushed through a $2 trillion stimulus package that enhanced unemployment benefits for the millions of filers who are collecting them right now.
Generally, you're entitled to unemployment benefits if you lost your job through no fault of your own (meaning, you were the victim of downsizing or a closure, and weren't fired for cause) and also meet your state's minimum earnings requirement. Your weekly benefit is then calculated based on your state's rate and your previous earnings.
Thanks to the aforementioned stimulus package, those on unemployment are entitled to an extra $600 a week on top of their standard weekly benefit. Unemployment benefits have also been extended by 13 weeks, and are now available to out-of-work freelancers, too (normally, self-employed workers aren't eligible).
If you're collecting unemployment benefits, or expect to be in the very near future, you'll likely come to regard that money as a financial lifeline. But before you start making plans to spend all of that money on essentials and bills, remember that unemployment benefits are considered income, which means the IRS gets a piece of them.
You can't avoid taxes on unemployment benefits
Just as you're required to pay taxes on the income you earn from a job, so too are unemployment benefits taxable. You'll generally get two choices for paying taxes on that money -- you can elect to have 10% of your weekly benefit withheld immediately, or you can make estimated quarterly tax payments to the IRS during the year.
The former is generally a safer bet if you don't want to end up with a tax headache on your hands next year. By contrast, to make estimated payments, you'll need to account for your total income, not just those weekly payments, which could get complicated. On the other hand, if you're truly desperate for cash, not withholding that 10% gives you a little more flexibility for collecting your money -- you get your entire weekly benefit up front, and it's then on you to manage that sum so you're paying the IRS its share eventually.
Reporting unemployment income on your tax return
If you receive unemployment benefits this year, you'll receive a 1099 form summarizing that income that the IRS will get a copy of as well. This means you won't be able to hide your unemployment income, and excluding it from next year's tax return could land you on the IRS's audit list.
You'd think unemployment benefits would be yours free and clear of taxes, since the whole reason you're collecting them stems from being out of a job. But unfortunately, any time you make money, the IRS is entitled to a share of it, and that includes the weekly benefits that may be keeping you afloat right now. Keep that in mind so there are no unpleasant financial surprises down the line.