New Law Provides
Tax Relief for Jobless Benefits 

During 2020, and now into 2021, over 70 million people received both federal and state unemployment benefits into the hundreds of billions of dollars. That means tens of millions of Americans were poised to be blindsided by IRS bills they would never see coming. The reason? Most people don’t know—and only find out the hard way—that unemployment benefits are taxed by the IRS as ordinary income. This means you would owe income taxes on the benefits. While some states don’t tax unemployment compensation, the federal government most certainly does. 

That’s the bad news.

The good news is that much of the surprise will be mitigated by a provision of the new COVID relief law. On Thursday March 11, President Biden signed the so-called American Rescue Plan Act into law. The new law represents another massive federal bailout (see Merrill Matthews’ article below), not just for individuals impacted by COVID, but for state and local governments, as well as union pension funds.

Among the benefits for individuals is a provision to exempt from taxation a portion of unemployment benefits. The law provides that up to $10,200 of jobless benefits are not taxed if one’s modified adjusted gross income is less than $150,000. The $150,000 cap is computed without considering unemployment compensation. 

Based on this, if your combined federal and state benefits are under $10,200, you will owe no taxes on those benefits. If they exceed $10,200, you will owe tax only on the portion that exceeds $10,200. The amount of tax you ultimately owe is controlled by your tax bracket. I recommend you calculate this as soon as possible to make payment arrangements if necessary.

As of this writing, millions of people who received unemployment compensation in 2020 have already filed their 2020 tax returns. Those people would have claimed the 2020 benefits as income and paid that tax based on that income. And that was the right thing to do, since the law, up to this point, has been that such benefits are taxable.

However, not only did the American Rescue Plan Act change that rule effective for 2021, but it applies retroactively to 2020. That means any jobless benefits you received in 2020 are likewise no longer taxable, up to the cap.

If you already filed your 2020 tax return claiming jobless benefits as income, you paid taxes you don’t owe. Now the question is what to do about it. The IRS tells us they will automatically make the required adjustment and send you a refund. Maybe that will happen, and maybe it won’t. If it does, fine. You don’t need to do anything. If it doesn’t, you will need to file an amended return to get your money back. You file an amended return by submitting IRS Form 1040X. You have three years from the date of filing the original return in which to submit the amended return.

An amended return will help you in either of two ways. First, if you already paid the tax in full, you’ll get a refund based on the reduction of income. Second, if you currently owe money to the IRS for 2020 because of an underpayment attributable to the jobless benefits, an amended return will reduce (perhaps eliminate) what you owe, including interest and penalties the IRS would otherwise charge.

Don’t waste any time taking the appropriate steps because it means putting money in your pocket, where it belongs.

What if I Owe Taxes Anyway? 

Because we saw record high numbers of people getting unemployment benefits in 2020, there is no doubt in my mind, even with the tax break on some unemployment benefits, that we will see record high numbers of tax delinquencies come April 15, 2021, as people discover they don’t have the money to pay what they owe.  

It is therefore imperative that people understand certain fundamental taxpayers’ rights to avoid the sword of IRS enforced collection action (levies, seizures, etc.). At a minimum, wrap your arms around the following three ideas.  

1. You have the right to seek an extension of time to pay your taxes. Most people understand they have the right to seek an extension of time to file their returns (IRS Form 4868). However (a common misunderstanding), the filing extension does not give you more time to pay. And while the IRS denies the existence of a payment extension, the procedure is most definitely available. 

You seek a payment extension by filing IRS Form 1127 on or before April 15. The payment extension is not automatic. You must show that you experienced “hardship” during 2020 and therefore cannot pay on time. Under our national COVID emergency, that should not be hard for most people. If granted, you can get up to six additional months to pay your taxes, without penalties. 

2. You have the right to seek an installment payment agreement if you need more than six months to pay. For many people, six months will not be enough time to pay in full. In that case, an installment agreement allows you to pay over an extended period. If you owe less than $50,000, and can pay within seventy-two months, the installment agreement is generally accepted by the IRS. 

You can apply for an installment agreement using IRS Form 9465. The bad news is that penalties continue to apply even if the agreement is accepted. However, you may seek cancellation of the penalties based on reasonable cause and “hardship” regardless. The good news is that once the installment agreement request is either pending or accepted, the IRS cannot pursue any collection action whatsoever. This keeps them off your back as long as you make your payments. For details on how to seek cancellation of IRS penalties, see The IRS Problem Solver, chapter 4. 

3. You have the right to have your delinquent account frozen as “uncollectible” in certain cases. If you are either unemployed or under-employed and your income is down considerably for any reason (COVID or otherwise), you can get your case closed as “uncollectible due to hardship.” This right arises out of Code §6343. 

This law prohibits the IRS from engaging in any collection action if such action will make it impossible for a citizen to pay basic, necessary living expenses. This is the legal definition of “hardship.” When you demonstrate the inability to pay because income and expenses are such that there’s nothing left at the end of the month for back taxes, the IRS will put your tax debt on the back burner. And while the debt is not extinguished, the collection freeze keeps the IRS out of your face while you get back on your feet.

Do not hide your head in sand if you will owe taxes you can’t pay this April. The above three steps, and many other taxpayers’ rights (discussed in my book How to Get Tax Amnesty), will keep you from getting run over by the IRS because of circumstances beyond your control.