Currently, more than 22 million Americans are collecting unemployment benefits, and that compensation is not free. Many unemployed workers have no idea that the benefit payments they receive in 2020 are taxable. So even those suffering a significant drop in total income due to a job loss this year could still end up with a tax bill next year.
“Most people don’t realize it. They are thinking about the moment. They don’t have a lot of savings, the credit is not great, and then on April 15, 2021, they have a big tax bill that they don’t expect,” he said. Ken Lin, CEO of Credit Karma, which offers a free online tax preparation service.
State unemployment benefits, as well as the additional $ 600 per week in coronavirus relief provided by the federal government under the CARES Act through July 31, account for your taxable income on your 2020 tax return.
Tax experts point out that you don’t have to pay Social Security and Medicare taxes on this money like you do on wages, but your unemployment benefits will be taxed by the federal government and possibly by your state. And if you don’t pay enough taxes throughout the year, you could also end up paying fines and interest.
Lin recalls receiving unemployment benefits after losing her job at a technology company in the early 2000s, and said she did not know that the compensation would be taxed. “Planning is what really matters. You can avoid all that by reserving dollars today,” he said.
Here are three strategies to avoid facing an unexpected fiscal impact on your unemployment benefits.
1. Request to have taxes withheld
2. Pay estimated taxes
If you do not want income taxes to be withheld, you can pay the estimated taxes each quarter. “If you are a small business owner or self-employed, you are more likely to make estimated quarterly taxes,” said Ortiz, who is also a member of the Committee on Personal Finance Specialists at the American Institute of Chartered Accountants. However, he added, this option may not work for many unemployed people.
3. Save part of your payment
Try to save 10%, or a portion, of each benefit payment. “Cash is king right now, and what’s really important is maintaining flexibility,” Lin said. “Put that money, that potential money on the tax bill, in a savings account, and then for a year you will have some flexibility in case things get worse.”
Unfortunately, the reality is that for millions of unemployed Americans, their financial lives are already worse than they expected.
Developing a strategy to avoid paying taxes next year may be the least of your concerns, Ortiz said. “If someone is struggling right now, they are saying, ‘Forget about withholding. Let’s put food on the table and keep the lights on. We will worry about taxes when the economy recovers.'”
SIGN UP: Money 101 is an 8-week financial freedom training course delivered weekly in your inbox.
CHECK OUT: What to do if you think your stimulus check is for the wrong amount through Grow with acorns + CNBC.
Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.