There has been much confusion around whether unemployment benefits under the CARES Act are taxable or not. As an unfortunate surprise to many, the unemployment benefits are indeed taxable. According to a recent survey by Jackson Hewitt, more than 37% of Americans have no clue that this is the case.


Although stimulus checks are not considered taxable income, those who receive unemployment assistance provided through the coronavirus relief bill will be required to report the income on their 2020 federal income tax return.


Below are three main elements that taxpayers should know regarding their unemployment benefits:


1. Unemployment compensation is taxable

You will need to include your unemployment benefits provided through the CARES ACT when you file taxes for 2020. Not including your unemployment benefits on your tax return could result in an assessment notice from the Internal Revenue Service (IRS) or your tax refund could be delayed.


2. Withholding Tax

According to Investopedia, a withholding tax is an amount that an employer withholds from employees’ wages and pays directly to the government. Unlike other sources of income or wages, unemployment benefits do not have automatic tax withholding. The IRS states that “people should have tax withheld from unemployment now to avoid a tax-time surprise.”


Recipients of the unemployment benefits can only request a withholding rate of 10% to cover a portion or all of their tax liability. If you qualify for the additional $600 per week in the first round of the relief bill, or the additional $300 per week in the second round, then a 10% withholding rate may not be enough. If possible, set a portion of money aside in your savings account so that you aren’t hit with a hefty tax bill.


3. Tax credits and deductions could be affected due to unemployment benefits

Those who live paycheck-to-paycheck but earn more money while receiving unemployment benefits could lose any earned income tax credit. Since unemployment benefits aren’t considered earned income, it will not count towards certain tax credits, which could reduce the full amount of tax credit that a taxpayer may be eligible to receive. Several tax credits have specific rules that require earned income to qualify for the credits.

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