You Received Unemployment Benefits During the Crisis. What Does That Mean for Your Taxes?
About the author: Lamar Watson, CFP®, is a Fee-Only Financial Advisor in the Washington, D.C. area, that works with clients virtually across the country. Lamar's work with his clients focuses on budgeting, employee benefits, paying down debt, buying their first home, and investing. Lamar is the Founder of Dream Financial Planning, a virtual financial planning firm specifically designed to help young professionals and minorities take control of their finances and fulfill their dreams. Feel free to schedule a complimentary consultation to learn how we use the The DREAM Financial Planning Process ™ to help our clients achieve their goals.
By the end of May 2020, over 20 million Americans claimed unemployment benefits.1 This payment can be a great relief to many who have found themselves out of work due to COVID-19. Many companies have been forced to lay off workers, while others simply have not been able to operate as a result of health risks, including restaurant and entertainment industry workers.
However, unlike the stimulus checks that were a part of the CARES Act, unemployment benefits (state benefits plus the government’s weekly benefit payments) are federally taxable and may also be taxed by your state.2 Rather than facing an unwelcomed tax burden during the 2020 tax season, we go through three options to help you prepare for next tax season.
Option #1: Request Tax Withholdings
Since federal income tax is paid in real-time as you earn income, employers are required to withhold a certain amount from your pay throughout the year that goes directly to the IRS. This eliminates the need to monitor your salary and make regular payments to the IRS. When it comes to unemployment compensation, though, tax is not automatically withheld. However, the amount received is still taxed federally (and may be taxed in your state as well) — so you may end up owing at the end of the year.3
To avoid this, you can opt to have federal income tax withheld by submitting a request to the IRS using Form W-4V.3 There may be additional steps necessary to complete depending on your state of residency. You can check with your state’s requirements through the U.S. Department of Labor’s CareerOneStop.
Option #2: Make Estimated Tax Payments
In fact, the IRS recommends doing so if you don’t elect to have taxes withheld or if a portion of your income is not automatically withheld.4 Not only does this save you from owing a hefty amount during tax time, but it can help you avoid or fix any issues that may come up, such as underpaying on taxes unintentionally. The IRS states that you can typically avoid any penalties by paying 90% of your tax throughout the year.5
To estimate your payments, the IRS advises using your previous year’s tax return as well as Form 1040-ES, Estimated Tax for Individuals. The payment considers your expected income and tax credits.5
If you began receiving unemployment compensation in April or June of 2020, the deadline to make estimated tax payments has been extended from April 15 and June 15 to July 15, 2020. After this, however, estimated tax payments will still be required according to the normal schedule.5
Option #3: Put a Portion into Your Savings Account
In some dire cases, it might not be possible to make consistent tax payments or to have a portion of your benefits withheld. If this is the case, whenever possible, put away part of your benefits compensation into a savings account. If you already have at least a small emergency fund accrued for the year, delegating this portion for your taxes can help you prepare for the 2020 tax season.
COVID-19 has brought about uncertainty in numerous forms with many individuals and families waiting to know when they can return to school, work and an overall normal way of life. For those who have experienced economic hardship and have needed to collect unemployment compensation, there are still proactive ways to ease your financial future. Saving for taxes, paying them as you go or requesting withholdings are three avenues to do so.
Dream Financial Planning Process ™
Whether you're managing student loan debt, starting a business, or considering buying your first home, the DREAM Financial Planning Process™ is tailored to the unique needs of busy professionals is their 30s and 40s. This process focuses more on short-term goals while you grow and evolve in your personal and professional life. If you're looking for guidance on: Financial Planning, optimizing employee benefits, budgeting, student loans, and managing your 401k or investments we can help.
With uncertainty surrounding the economic stability of our country, it's okay to have fears and anxieties surrounding your own savings and investments. The most productive course of action from here is to reach out to Dream Financial Planning (or whoever your trusted advisor might be) and discuss your options. It's easy to have knee-jerk reactions when it feels like the bottom is falling out, but it is imperative to make decisions using research-backed data and a level head. If you'd like a Complimentary Review and risk assessment of your investment portfolio feel free to send me an e-mail.
On the first Thursday of every month I send out a monthly newsletter with tips and tricks to help you manage your Finances. In the July Newsletter I shared an article that discusses Regulation Best Interest vs. the Fiduciary Standard. I also included two downloadable PDFs. One highlights how to make sure your Health Savings Account (HSA) distributions are tax-free. The other provides guidance on if you should contribute to a Roth or Traditional IRA.
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