Not Even the Unemployed are Exempt Come Tax Time

by John Kiernan on February 10, 2011

TaxesIn the current economic climate, many of us know people who have lost their jobs. A couple of my good friends have unfortunately felt such ill-effects of the Great Recession, and as I was talking to one of them the other day, I asked about his job search. He explained to me how he was going through the interview process and was optimistic about a few opportunities.

I congratulated him and quipped, “The one good thing about not having a job right now is that you don’t have to file taxes. No forms, no giving back some of your unemployment check; there’s a bright side to that.”

“Actually,” he responded, “You have to pay taxes on unemployment, so there goes that lemonade you were trying to make me.”

This shocked me and piqued my curiosity. I had no idea unemployment benefits were taxable, so I looked into the matter a little more.

As it turns out, unemployment benefits are considered part of your gross income, and you must pay taxes on them as you would with typical earnings. While many people might consider this odd or even unfair given that unemployment benefits are provided by the government as assistance in the absence of work, you are technically being paid when on unemployment, so, as the IRS sees it, this money is fair game. Never mind that it would be simpler to have lower unemployment benefits that are tax-free than it is to be given money by one government agency only to have part of it taken away by another.

Therefore, I was still perplexed and decided to research the matter further.

According to the Internal Revenue Service website, “unemployment compensation generally includes:”

  • Any unemployment benefits received under federal or state laws
  • State unemployment insurance benefits
  • Benefits paid from the Federal Unemployment Trust Fund
  • Railroad unemployment benefits
  • Disability benefits
  • Trade readjustment allowances under the Trade Act of 1974
  • Disaster-related unemployment

So, armed with such information, the personal finance enthusiast in me emerged and I tried to find out whether any loopholes existed within the unemployment tax law that could help lessen my buddy’s burden. Interestingly, unemployment benefits received from private (and sometimes public) funds that you contributed to voluntarily in the past are not taxable as long as the benefits you receive do not exceed the value of your contributions.

Therefore, I called up my friend and asked if, before losing his job, he had ever donated money to any charities or funds established to help out-of-work people. While he had not, this could prove important to some of you out there currently receiving unemployment assistance. However, it’s important to point out that unemployment considerations from a “company financed fund … are taxable as wages,” according to the IRS.

What did prove useful to my pal is the fact that there are payment options for unemployment taxes. He can decide to have 10% of his unemployment income withheld on a monthly basis for tax purposes, make quarterly estimated tax payments or, in some cases, simply pay a lump sum come tax time.

My advice to him: Pay in the manner that best suits your current financial needs. Many people on unemployment need every penny they receive to pay for food and housing. So, while having your taxes withheld would be convenient, it might not be practical. Still, if you decide against having your income tax withheld, you must be careful to save the requisite money to pay your taxes come the end of the fiscal quarter or year.

Remember though, expenses related to your job search—such as the cost of resume production, placement services and even and some interview travel—are tax-deductible. People without work may qualify for other deductions or tax credits as well. Ways therefore exist to lower the burden of the unemployment tax. You must simply do a little bit of research to find out how they apply to your particular situation.

[Disclosure: Some of the links within this article point to, which is owned by the same parent company as Wallet Blog.]

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