What You Should Know About Unemployment Benefits and Income Tax

A sign hangs outside the Internal Revenue Service building in Washington.
The Internal Revenue Service building in Washington is shown on May 4, 2021. (Patrick Semansky/AP File Photo)

If you collected unemployment benefits in 2009, the last thing you need in 2010 is to pay too much in federal income tax. To minimize what you owe, take advantage of every job search-related tax deduction you can as well as the tax break you get on the first $2,400 in unemployment compensation.

Hopefully, you had taxes withheld from your unemployment benefits above that first $2,400; if not, you could have a big tax bill due in April.

How much federal tax you pay depends on your tax bracket, says Sue Medicus, a certified public accountant (CPA) and owner of several Liberty Tax Services locations in Baltimore. At least you'll know exactly how much unemployment compensation you collected; you should have gotten a 1099-G showing that information before Jan. 31.

How much you'll owe your state varies. Some states, like California, don't tax unemployment compensation, but others, like Massachusetts, do, says Rob Seltzer, a Los Angeles CPA.

Didn't Withhold Enough?

When you started collecting unemployment, you had the option to have the state withhold 10% of your check for taxes. But what if you didn't have enough -- or any -- taxes withheld and you don't have the money to pay what you owe in April?

"Ask to set up an installment payment plan with the government," Medicus said. "Usually, they're pretty agreeable. If you really can't pay at this point and you're willing to disclose the financial information to prove it, they'll put you in uncollectible status, meaning they're not going to go after you right now."

The IRS will take the amount you owe out of any future refund. It may also charge you a penalty, if it thinks you should have known better. "If you've under-withheld in the past, then they might be more likely to charge a penalty," Medicus said. "If you haven't owed in the past and the problem was sudden, they may waive penalties, but they rarely waive interest on what you owe."

Making Work Pay Credit

The 2009 stimulus payment of $400 for singles and $800 for couples was delivered throughout the year by reducing withholding for most employees. You can make as little as $12,903 for a couple or $6,451 for a single person and qualify.

If you stopped getting paychecks before you collected your $400, you may qualify to get the rest at tax time. If you made less than $6,451 as a single filer or $12,903 for joint filers, then you may come up short on withholding. If so, you could potentially owe more in taxes because you didn't earn enough to qualify and will have to pay back what you were given in your weekly pay packet.

Health Insurance Deduction

If you paid for your own health insurance -- either privately or via the Consolidated Omnibus Budget Reconciliation Act, or COBRA -- you may be able to write off the cost. "However, many laid-off workers will not receive any tax benefit, because for starters, they must itemize deductions on Schedule A and additionally, the total of all unreimbursed medical expenses, including insurance premiums, must exceed 7.5% of their adjusted gross income," IRS spokesperson Eric Smith said.

Job Search Deductions

You can also reduce the amount of federal tax you owe by deducting your job search expenses. "Job search expenses are deductible for people who itemize and are looking for work in the same field," Smith said. However, about two-thirds of all filers do better by claiming the standard deduction, he says.

Seltzer notes that items you can write off include:

  • Getting resumes prepared (paying a writer, getting them printed)
  • Traveling to interviews (mileage or airfare)
  • Job coaching

"Save receipts and document everything, so in case you do get audited, you have the proper documentation to back up the deductions you've taken," he said.

Your telecommunication bills could also be deductible. If you used your computer and internet connection three hours a day for your job search and three hours a day to update your Facebook page, you could deduct half your internet service costs, Medicus says. A log showing how much time you spent on the internet and your cellphone for your job search will prove your deduction is legitimate if you're audited.

Education Deductions

If you went back to school, you can use the American Opportunity Tax Credit, which offers up to a $2,500 tax credit for tuition, fees and books, says Melissa Labant, a technical tax manager for the American Institute of Certified Public Accountants in Washington, D.C.

Unlike deductions, credits count dollar for dollar against what you owe in taxes. If you owe $100 and you have a $100 tax credit, you owe nothing. This one is partially refundable, so you can use it to get a refund, if you qualify.

You may also be able to deduct the cost of courses taken to improve your existing skills, Labant adds. In one particular case, the United States Tax Court recently ruled that the cost of education to help you make yourself more attractive as an employee, rather than to qualify you for a new profession, was deductible.

Can you deduct the cost of industry certification? "If it qualifies you for a new job or it's required for your job, you can't deduct it, but if you're taking it to make yourself more attractive as an employee, it's deductible," Labant said.

Moving Deduction

If you moved more than 50 miles to take a new job, you may be able to deduct your moving expenses. That would include the cost of shipping your household goods, finding a new home and selling your old home, and getting yourself to the new location.

Tax-Prep Deduction

If all this tax talk gives you a headache, consider hiring a pro or using professional software to do your returns. The cost is deductible.

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