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Millions of Americans who collected unemployment benefits last year got a new tax break from the American Rescue Plan.
Is that how it works.
$ 10,200 tax exemption
Unemployment benefits are generally treated as income for tax purposes. The new tax exemption is an “exclusion”: Workers exclude up to $ 10,200 in unemployment benefits from their taxable income for 2020.
Individuals should receive a Form 1099-G showing their total unemployment compensation for the past year. The number is in box 1 of the tax form.
For married couples, each spouse can exclude up to $ 10,200 from their benefits. That would reduce the couples’ joint taxable income by a maximum of $ 20,400.
Amounts over $ 10,200 per individual are still taxable.
For example, let’s say a married couple has a combined income of $ 100,000. That income includes $ 20,000 in benefits for one spouse and $ 5,000 for the other.
This couple can exclude $ 15,200 in taxes. (The first spouse only gets a break with $ 10,200 of the $ 20,000.) The couple would pay federal taxes on $ 84,800 of income instead of the initial $ 100,000.
Who is eligible?
Not everyone qualifies for the tax cut. Only people who made less than $ 150,000 in 2020 are eligible.
This income threshold works like a cliff: Anyone who made $ 150,000 or more last year doesn’t get any of the tax breaks.
The maximum limit of $ 150,000 is the same for all taxpayers, regardless of their marital status, such as single or married.
One wrinkle: Taxpayers should use the total of their unemployment benefits received when determining their income eligibility for the tax exemption.
Let’s say a couple earned $ 140,000 in combined earned income last year. Each spouse also received $ 6,000 in unemployment benefits. Their total income would be $ 152,000, which would disqualify them from the tax exemption.
Modified adjusted gross income
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The $ 150,000 income limit technically refers to a measure known as “modified adjusted gross income.”
MAGI is a number that the government uses to determine eligibility for some other tax exemptions. (For example, a single taxpayer cannot take a student loan interest deduction this year if their MAGI is $ 85,000 or more.)
Taxpayers will need to do a calculation to determine their MAGI in 2020.
The formula uses information on Form 1040 and Schedule 1.
The IRS details the MAGI calculation (and how to claim unemployment tax relief) in the online instructions posted Friday. They are titled “New Unemployment Compensation Up to $ 10,200 Exclusion.”
“I think the cool thing is that they were able to adopt an existing form that allows people to get excluded,” Janet Holtzblatt, a senior researcher at the Urban-Brookings Center for Tax Policy, said of the IRS. “They didn’t have to come up with a new way.
“That is really very efficient.”
The IRS is working with online tax preparers to update current tax software so taxpayers can determine how to report their unemployment income on their 2020 tax return, the agency said Friday.
It seems that digital tax preparers need more time before their software can account for the new rules.
“We are awaiting additional guidance from the IRS on how the unemployment exclusion will be implemented,” said Lisa Patterson, a spokeswoman for H&R Block.
TurboTax expects the updates to be available to taxpayers later this week, according to spokesperson Dominique Koudsi.
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The IRS listed some other important notes for taxpayers regarding Form 1099-G.
States can issue separate 1099-G forms for statewide benefits and the federal CARES Act weekly supplement of $ 600 paid through July of last year. If so, the two numbers must be added.
States can submit the forms by mail or electronically. Workers should check state unemployment compensation websites for more information..
If the amount reported in Box 1 of Form 1099-G is incorrect, report only the actual amount of unemployment compensation paid in 2020, according to the IRS. This number would go on Schedule 1 (Form 1040), line 7, Unemployment compensation.
Additionally, workers who overpaid unemployment benefits in 2020 must subtract the amount reimbursed from the total amount received, the IRS said. Enter the result on line 7. Also enter “Refunded” and the amount you paid on the dotted line next to line 7.