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Congress could soon offer unemployed Americans a tax break. States cannot be so generous.
The Senate on Saturday passed a $ 1.9 trillion Covid Relief Act that waived taxation of up to $ 10,200 per person in unemployment benefits in 2020.
President Joe Biden is expected to sign the bill this week after it is passed by the Democratic-run House of Representatives.
However, the tax policy that applies to households that have earned less than $ 150,000 is just a break with federal income taxes for workers.
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More than half of the states levy an income tax on unemployment benefits. If Congress waives federal income tax, states must decide whether to offer the break as well.
Some might still opt for unemployment benefit taxation, experts said.
For example, let’s say an employee received $ 10,000 in benefits over the past year. That person would still pay a tax charge of $ 500 in states with 5% income tax (if we assume a flat tax rate).
“It’s complex,” said Jared Walczak, vice president of government projects at the Tax Foundation. “Even many state officials are probably not sure what will happen next.”
Federal policy aims to prevent a surprising tax burden for the unemployed.
About 40 million people received unemployment benefits last year, and the average person received $ 14,000 in benefits, according to a report by the Century Foundation.
However, less than half of the recipients had withheld taxes, the report said. In some cases, states did not offer the option.
But the relief law is now changing the rules in the middle of the tax season, which started February 12th and ends April 15th.
This creates confusion for taxpayers, accountants and policy makers.
According to Walczak, 35 states and the District of Columbia typically tax unemployment benefits as income.
Three states – Maryland, Arkansas, and Delaware – usually do this, but waive the tax on benefits received in 2020.
The other states do not tax unemployment benefits – because they have no income tax or because unemployment benefits are tax exempt.
The state legislature has to decide how to proceed and its decision is time sensitive. Many laid-off workers may be waiting to file their taxes until there is more clarity.
There is a precedent for waiving the unemployment income tax. In 2009, during the Great Recession, Congress exempted the first $ 2,400 in unemployment benefits from tax, and many states followed suit, Walczak said.
However, that rule change did not take place during tax season, he said.
Many state lawmakers may find it difficult to embrace the change because they have already included tax revenue in their budget estimates for the current fiscal year, said Verenda Smith, associate director of the Association of Tax Administrators who works with state tax officials.
States may need to pull money from other budget areas like education to compensate for this, she said.
“It’s not easy to follow,” said Smith. “It’s a tough, tough budget decision for them.”
It wouldn’t be surprising, however, if many states eventually adopted federal taxation policies, given America’s financial troubles, she added.
According to the Ministry of Labor, more than 18 million people are still receiving unemployment benefits.
“That kind of thing draws people’s hearts,” said Smith. “It would be very difficult for an elected official to vote against such a thing.
“That’s just a political reality,” she added.
Extensions and changed tax returns
It is likely that taxpayers who received unemployment benefits last year and have already filed their tax return will have to file an amended return in the future.
But they should wait until the American bailout plan becomes law and the IRS, Treasury Department and respective states have more clarity about it, experts said.
The IRS allows up to three years after the original filing date to file an altered return and request a refund.
Employees who have not yet submitted feedback should, according to experts, consider requesting an extension of the registration period.
This does not exempt them from paying tax until the April 15th tax deadline. You must estimate and pay taxes owed to avoid penalties.
However, there is extra time to see what state and state lawmakers are doing.
When unemployment tax waiver becomes law, those requesting an extension will be able to remove unemployment benefits (up to $ 10,200) from their income when estimating their federal tax liability for 2020, according to Walczak.
In states that rate unemployment income taxes and have not yet offered guidance on new federal regulations, workers shouldn’t deduct benefits when estimating state tax if they want to be conservative, he added.