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Jobless? Uncle Sam Still Taxes Your Unemployment Benefits

CEH12J A man with empty pockets man; empty; pockets; poor; bad; bankrupt; bankruptcy; broke; business; cash; concept; credit; cr
The economic recovery has left millions of Americans behind, struggling to find jobs and leaving millions unemployed for extended periods of time. Yet as April 15 approaches, many unemployed people discover that the Internal Revenue Service wants its share of the meager unemployment benefits that they've received.

How Unemployment Benefits Get Taxed

Most benefits you receive from being out of work are subject to federal income tax as unemployment compensation. The IRS defines unemployment compensation as including money you get either from the federal government or from various state governments under unemployment-insurance laws, which includes the most common forms of unemployment benefits for the vast majority of recipients. In addition to general state and federal unemployment insurance, more specialized benefits like those under railroad unemployment rules also get treated as taxable income.

For the most part, even though benefits are subject to federal income tax, you don't have to pay additional taxes like Social Security or Medicare withholding. But some unemployed people get additional assistance from private funds that their employers contribute to on their behalf. In those cases, not only are the benefits taxable, but you might even have to pay additional withholding taxes and treat them the same way that wages and salaries get handled.

On the other hand, other people have jobs at which they themselves make voluntary contributions to private funds that pay benefits to unemployed workers. If you receive benefits from that type of fund, then you only pay tax on the amount you receive that exceeds what you contributed to that private fund.

Why Does the IRS Tax Unemployment Benefits?

The rationale for including unemployment benefits as taxable income is that they're meant to replace wage income that you'd earn if you actually had a job. As a result, if you're getting unemployment in lieu of working, then the IRS believes it makes sense to treat those benefits the same way it would treat your salary, wages, and tips.

Yet in other areas of the tax laws, the IRS doesn't treat unemployment benefits the same way. For instance, if you want to contribute to a Individual Retirement Account or something similar, you need to have what the IRS calls earned income. Earned income includes wages and salaries, but it explicitly excludes unemployment compensation. Moreover, several states, including California, New Jersey, and Virginia, exempt unemployment benefits from state income tax laws.

Nevertheless, despite some of these inconsistencies, it doesn't change the fact that you need to prepare to give the IRS its share of your unemployment check.

What to Watch For

One thing to check is whether you've had taxes already withheld from your unemployment benefits before you receive them. If you completed a voluntary withholding request on Form W-4V when you signed up for benefits, then the 1099-G tax form that you'll get should have both the total unemployment benefits you received and tax you've paid. Be sure to include that tax in the payments line on your tax return to get proper credit.

On the other hand, many people run don't have enough tax withheld. If that's the case, then you might owe even more to the IRS in interest and penalties. To avoid that problem in future years, many unemployed people must pay quarterly estimated taxes and spread out their tax payments throughout the year.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+.

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Unemployment benefits should be taxed . It's income, .

March 24 2014 at 10:29 AM Report abuse +1 rate up rate down Reply

Hey Obama , you should be impeached !

March 22 2014 at 10:52 PM Report abuse -1 rate up rate down Reply

Hey Barry, how'syour Somallian Pirates doing ?

March 22 2014 at 10:48 PM Report abuse rate up rate down Reply

Obama is turning unemployment compensation into another welfare scam. It was never intended to be used long term.

March 22 2014 at 1:18 PM Report abuse rate up rate down Reply

This is a minor issue compared to the bigger picture. Soon robots are going to be doing everything. Right now cashiers are being converted to robots by automatic ring-out machines.
90% of all jobs are going to be done by robots. Out of necessity we will have to increase unemployment benefits to three years, lower the retirement age by ten years, and increase the scope of WiC, foodstamps, and Medicaid. Or create new robo benefits.

March 22 2014 at 8:56 AM Report abuse rate up rate down Reply

yes they do this and the state will come after you for them taxes and take everything even if you do not work they don't care they come after you back account and anything they can get. this country has gone so downhill and it is not obama dem or rep it is all of them so please don't reply this is because of obama. this country has a bad case of head up ass and getting very bad.

March 22 2014 at 7:51 AM Report abuse +2 rate up rate down Reply

Please can somebody give me back my crack pipe.

March 21 2014 at 8:58 PM Report abuse rate up rate down Reply

skcarcomed_2, demsbaitnswitch3 ,.......you two sound just like the other crackpot conservatives that live in my trailer park.

March 21 2014 at 8:34 PM Report abuse rate up rate down Reply

I try to help my fellow conservatives. I tell them to buy a power tooth brush that way they don't have to do it manually any more.

March 21 2014 at 8:27 PM Report abuse -2 rate up rate down Reply

Word of advice to all. Be careful when you move from one State to another. I moved from a State with no State taxes to another State with state taxes. I was over my maximum yearly earnings and had to pay the IRS state taxes. I got hammered!!!. Big mistake!. I learned my lesson with that one. Don't make the same mistake I did.

March 21 2014 at 8:23 PM Report abuse rate up rate down Reply