How do Unemployment Benefits Affect Your Taxable Income?

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When the Covid-19 Pandemic first started, it was unclear how long some people would be out of work. More than half a year later, many individuals in the United States were forced to file for unemployment temporarily. Some people are still receiving unemployment benefits to date. As we prepare for the next tax season, many individuals are wondering about the tax implications of unemployment benefits.

What Taxes Must PA Residents Pay on Unemployment Compensation?

Unemployment benefits are a form of government aid and are considered taxable income because it is a substitute for standard income. Therefore, you must pay federal taxes on all unemployment compensation. However, state and local government taxes differ regarding unemployment compensation. In the State of Pennsylvania, individuals receiving unemployment compensation do not have to pay state and local taxes on the income they receive from unemployment benefits. 

Approaches to Paying Income Tax on Unemployment Benefits

There are three different approaches you can take to paying your income taxes on unemployment benefits. The first approach would be to fill out a W-4V. This will allow the government to withhold ten percent of your unemployment income to pay for federal taxes. The second approach would be to set aside a portion of your income each paycheck. Then you would pay estimated quarterly taxes on your income. The third approach would be to save the estimated amount of taxes you think you will owe for the year from your unemployment compensation. Then you would pay the taxes when you file the following spring. 

This safest approach is to fill out a W-4V and have the money withheld from your unemployment income. With the other approaches, you put yourself at risk for not having the proper financial resources to pay your taxes. Also, not fully paying your taxes throughout the year, may result in an underpayment penalty from the IRS.

How Unemployment Benefits Affects Tax Credits

Unemployment income can also affect what tax credits you are eligible for when filing your taxes. Many individuals received an additional $600 of federal unemployment from the Cares Act. This may make them ineligible for tax credits that they had received the prior year. If you have received unemployment benefits, it is important to evaluate what tax credits you will be eligible for when filing your taxes this upcoming year.

To learn more about this topic, visit the PA Office of Unemployment Compensation Website.

If you have any questions or concerns regarding the tax implications of unemployment benefits, we encourage you to reach out to us here.