Millions of Americans are going to be in for a rude awakening this tax season when they discover they owe the IRS money for unemployment payments. 

About 40 million Americans received unemployment insurance benefits last year, according to a recent report from the left-leaning Century Foundation authored by Brian Galle and Elizabeth Pancotti. That amounted to over $580 billion in benefits. The average beneficiary received a total of about $14,000 in unemployment benefits last year. 

Yet researchers estimate that only 40% of unemployment payments in 2020 had taxes withheld. That's important because unemployment benefits are considered taxable income, including the $600 and $300 enhanced benefit payments that lawmakers approved last year.  

While those on unemployment don't have to pay Social Security or Medicare taxes — typically about a combined 7.65% rate — you do have to pay federal income taxes and state taxes in some jurisdictions. 

Some states waive income taxes on unemployment checks. If you live in states like California, Montana, New Jersey, Pennsylvania and Virginia, your unemployment benefits are tax-exempt. Additionally, seven states — Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming — do not levy any state income taxes.

State unemployment agencies are required to offer the option to withhold 10% of benefits for income taxes, yet the Century Foundation reports that not all states immediately set up this option. And many out-of-work Americans could not afford a 10% reduction in their benefits.

That means millions of workers could owe "thousands of dollars per family" in unemployment benefits on their 2020 taxes, according to Galle and Pancotti.

In addition to regularly applied unemployment insurance payments, Americans could have received $600 weekly enhanced unemployment benefits for 17 weeks, plus an additional seven weeks of $300 weekly boosts. 

That means an average worker who was laid off on March 15 during the initial wave of stay-at-home orders and who was unable to find work last year would have received a total of $27,315 in unemployment payments, assuming they were eligible for state benefits and all of the enhanced payments, according to the Century Foundation report. All of that is considered taxable income.

If you are still unemployed and receiving benefits, double check that you've opted into withholding. You should be able to change or stop withholding at any time. To request withholding, you need to fill out form W-4V (the "V" stands for voluntary). Depending on your state, this may be something you can do online through the benefits portal. A flat federal tax rate of 10% of the benefits paid can be withheld from each payment, according to the Labor Department. 

You could also go the do-it-yourself route and set up a savings account where you set aside funds to pay any income taxes you may end up owing on unemployment benefits. TurboTax has a W-4 withholding calculator that can help you calculate your estimated payment, or you can opt to work with an accountant. 

Some lawmakers are working to mitigate the fallout for those who have been collecting unemployment for weeks or months during the Covid-19 pandemic. Senator Dick Durbin, D–Ill., and Rep. Cindy Axne, D-Iowa, re-introduced the Coronavirus Unemployment Benefits Tax Relief Act earlier this month that would exempt the first $10,200 of unemployment compensation from federal income taxes in 2020.

Senator Bernie Sanders, I-Vt., has also thrown his support behind tax forgiveness on unemployment benefits and a dozen members of Congress on Thursday sent letters urging Democratic leaders to include a tax waiver in the $1.9 trillion relief package proposed by the House, which is slated for a vote on Friday.

Currently, the legislation does not include any such tax exemptions, so it remains to be seen if Americans who suffered unemployment over the past year will get a break. 

"There's no sound or ethical rationale for requiring millions of Americans to search the couch cushions for pennies or forgo putting food on the table to pay tax bills they shouldn't owe," write the Century Foundation's Galle and Pancotti. 

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