Your unemployment compensation is taxable income

The coronavirus pandemic has brought numerous changes to our way of life and the economy as a whole.

Unemployed Americans have gone from one of the lowest percentage figures in history prior to the pandemic to one of the highest in a very short period of time. Many people have applied for and have begun receiving unemployment compensation, while millions of others are still waiting to have their claims processed and receive their unemployment compensation.

The unemployment application system has been overwhelmed with the number of claims and many Americans are still struggling to have their claims processed.

While receiving unemployment compensation may cushion the blow of losing one’s primary source of income, it is important to be aware that this unemployment compensation is taxable income and that come tax-filing time next year you will need to report this income and pay federal and state income taxes on this income. Unemployment compensation is not free money, and you need to plan accordingly. Americans need to take a number of steps to avoid a nasty surprise come tax-filing time next year.

As a result of this pandemic, the amount of the unemployment compensation has also increased dramatically as well, as the eligibility criteria the CARES Act expanded these coverages and limits. In addition to the regular weekly unemployment amount that a claimant would receive, each claimant is also receiving an additional $600 per week above and beyond the unemployment compensation that they would normally qualify for. This $600 in additional unemployment compensation is also taxable and needs to be considered when planning for income tax obligations down the road.

In addition to the increased level of unemployment compensation, the eligibility criteria has been expanded significantly.

Prior to this pandemic, a selfemployed individual or a business owner would not qualify to receive unemployment compensation. However, the CARES Act created the Pandemic Unemployment Assistance program which expanded the eligibility to include independent contract, self-employed individuals, gig workers and others who would not traditionally qualify for assistance.

Traditionally unemployment compensation paid claimants an average of $400 per week in Ohio. Under the new rules, unemployed Ohioans are now getting benefits of approximately $1,000 per week as a result of the additional $600 per week from the CARES Act.

It does not take long to rack up a significant income tax obligation when one is receiving $1,000 per week. In many cases, the amount that an unemployed worker is receiving actually exceeds what they were making when working.

The unemployment agency can and will withhold income taxes if the recipient instructs them accordingly.

However, because the recipient is out of work and needs funds they may forget about the future income tax obligation. Unemployment compensation is subject to both federal and state income taxes, but not Ohio local taxes as it is not earned income. However, when applying the only choices for withholding are no withholding or 10% withholding at the federal level. There is no option to withhold Ohio taxes.

Since each taxpayer has their own marginal income tax rate based on all of their other income, the 10% withholding is probably not sufficient to cover the future income tax obligation related to the unemployment compensation that was received. For some taxpayers the resulting income tax obligation could approach 37% for federal and 5% for state, so it is very important to plan accordingly.

It would be in a recipient’s best interest to set aside money for the future federal and state income tax obligation.

The resulting income tax obligation is based on the other income of that taxpayer, and may include the income of the taxpayer’s spouse as well if the unemployment recipient is a married taxpayer and files a joint income tax return.

The unemployment compensation is certainly a muchneeded blessing for those that have been hardest hit by the coronavirus pandemic. To avoid the receipt of this unemployment compensation becoming a curse, it is important to plan appropriately and to assess the need to set aside funds for the future income tax obligation.