Americans who lost their jobs last year and have already filed their tax returns will have one less headache to deal with.
The Internal Revenue Service will automatically recalculate their returns to account for the new stimulus tax break on the first $10,200 of unemployment compensation received in 2020, the agency said Wednesday. It will then send any refund directly to taxpayers, likely starting in May and continuing into the summer.
The provision, which applies to filers with modified adjusted gross incomes of up to $150,000, is part of the Democrats' $1.9 trillion stimulus package that President Joe Biden signed on March 11. But that was after millions of people had already filed their 2020 returns.
For those who have already filed, the agency will do the recalculations in two phases, starting with those eligible for the up to $10,200 exclusion. It will then adjust returns for married taxpayers filing joint returns who are eligible for the up to $20,400 exclusion and for others with more complex returns.
The IRS had previously signaled that people who received benefits last year should not submit amended returns, saying it would provide additional guidance.
Some taxpayers, however, will still need to file an amended return since the tax break might make them newly eligible for certain federal credits and deductions. For instance, they may now qualify for the earned income tax credit or for a larger credit amount.
Plus, filers may want to review their state income tax returns since some states are also offering the tax break.
For those who have yet to complete their 2020 federal return, the IRS recently provided instructions and a worksheet to guide taxpayers with unemployment compensation through filling out the correct amounts on Schedule 1 of Form 1040. The IRS has also moved the standard April deadline back a month, to May 17, as the agency puts the new stimulus into effect.
The agency also announced Wednesday that it has worked with the tax return preparation software industry to reflect these updates and provide appropriate questions for those preparing their returns electronically.
Avoiding surprise tax bills
Lawmakers included the tax break to help laid-off workers avoid surprise tax bills on their jobless benefits. Many Americans either did not realize that unemployment benefits were taxable or opted not to have income taxes withheld from their payments.
State unemployment agencies transferred only $22 billion to the IRS for withholding purposes last year, much less than the $58 billion that would have been sent had all of the jobless elected to withhold at the federal flat rate of 10%, according to a letter Democratic Rep. Cindy Axne of Iowa, who pushed for the provision along with Sen. Dick Durbin, an Illinois Democrat, and other representatives sent to House leaders in February.
The tax relief measure is similar to the one given to laid-off workers during the Great Recession. The 2009 American Recovery and Reinvestment Act provided a tax break on up to $2,400 in unemployment benefits.
However, that provision was passed nearly a year before the tax season started, giving the IRS time to provide instructions in its tax documents. The 2009 tax return contained a line for taxpayers to list "unemployment compensation in excess of $2,400 per recipient."
Also, fewer people qualify for the current tax break, which is limited by income. Those determining whether they are eligible for the $10,200 exclusion do not have to count any unemployment benefits as part of their calculations of modified adjusted gross income, according to Mark Luscombe, principal federal tax analyst at Wolters Kluwer Tax & Accounting.
Historic expansion of unemployment benefits
The tax break on unemployment comes nearly a year after Congress passed a historic expansion to the nation's unemployment system to cushion the millions of Americans who were laid off during the coronavirus-fueled economic downturn.
Lawmakers provided hundreds of dollars a week in federal enhancements to benefits, extended the duration of payments and opened up the system to freelancers, gig workers, independent contractors and certain people affected by the outbreak.
More than 23 million workers filed for benefits last year, according to federal data.
Since the start of the pandemic last March, federal and state governments have spent more than $650 billion on unemployment payments, according to Jared Walczak, vice president of state projects at The Tax Foundation.