When Gale Nichols received her tax forms last month, she was in shock. Even though she opted to have California withhold 10% of her unemployment benefits, the state did not take any taxes out of the enhanced federal payments.
In addition to the standard state unemployment benefits, lawmakers last year approved extra weekly $600 payments made under the Federal Pandemic Unemployment Compensation (FPUC) program. When that expired in July, an additional $300 weekly boost was provided through the Lost Wages Assistance (LWA) program.
Yet some states, including California, did not apply the 10% tax withholding to these specialized payments, even though that money is taxable.
Nichols, a 63-year-old executive administrative assistant for a nonprofit, was furloughed in March and just recalled to her job in January. The "saving grace" for her financially was the fact that her husband is self-employed as a property manager, Nichols says.
Knowing she'd have to pay taxes on her unemployment, Nichols tried to be proactive by opting to have the state withhold a portion of her payments in advance. But when her 1099-G arrived in the mail, she discovered she's on the hook for taxes on $23,076 of her unemployment benefits. "It was a complete surprise to me," she says. "I just feel like we're behind the eight ball and they threw us to the fishes."
"I don't understand why, when I told them to withhold the 10%, they only withheld it from the actual unemployment money, not what I call the 'bonus money,'" Nichols says. "I think it would have been a safe assumption if you check a box to withhold taxes, that you withhold taxes from all the money that they're going to be sending you."
Nichols is waiting to file her 2020 taxes in hopes that the $1,400 stimulus payments will hit her bank account before her taxes are due and can help her cover her tax bill. Otherwise, she's planning on taking money from her individual retirement account (IRA) to cover the extra expense.
"People who don't have jobs are on the hook to come up with this money in a time when money is very difficult to come by," Nichols says.
California's Employment Development Department said in an emailed statement to CNBC Make It that out-of-work residents are given the option to withhold on standard state-issued unemployment insurance and federal pandemic unemployment assistance benefits.
"This withholding option was not available for the $600 pandemic additional compensation payments, which needed to be quickly implemented at the time to get benefit funding to eligible claimants in need of them," says Loree Levy, deputy director of public affairs. Levy did not comment on whether this was also the case with the $300 enhanced unemployment payments.
It's not just California that didn't withhold taxes
It's not just California where unemployed Americans are finding that only part of their benefits payments were withheld. A Minnesota resident, who asked that her name be withheld to protect her privacy, tells CNBC Make It that she collected over $16,400 in unemployment benefits last year.
While she also opted to have 10% withheld from every payment for taxes, she similarly discovered that the withholding was only applied to her standard unemployment benefits. She now owes over $1,000 in taxes to her state and her federal return was reduced by over $2,000.
Minnesota's Department of Employment and Economic Development did not respond to requests for comment.
Workers in Hawaii have also reported issues with withholding taxes on all or some of the federal employment programs, according to Elizabeth Pancotti, policy director at Employ America.
A spokesperson for Hawaii's Department of Labor and Industrial Relations confirmed to CNBC Make It that while workers may opt in to having state and federal taxes withheld, the state did not withhold taxes from the $300 payments made through the LWA program or the Pandemic Unemployment Assistance (PUA) program designed for gig workers, independent contractors, the self-employed and those who would normally not be eligible for unemployment. The spokesperson said Hawaii did withhold taxes when requested from the $600 FPUC payments and standard unemployment benefits.
While CNBC Make It could only confirm the withholding issues in a handful of states, that doesn't mean it's not happening elsewhere as well, says Nicole Marquez, director of social insurance at the National Employment Law Project. There could be many more states added to the list as more Americans start to do their taxes and discover issues.
Experts say that they're not at all shocked to see issues like this cropping up in multiple states, especially considering that many were trying to get their unemployment systems set up to process the new federal enhanced payments amid the pandemic as rapidly as possible.
"It's not surprising that in general, the states just want to send out the flat amount to everybody and not have any modifications to it, because any modifications to it will require an additional level of programing," says Andrew Stettner, a senior fellow at the Century Foundation and leading unemployment insurance expert.
These workers jumped through all of the right hoops to get access to unemployment benefits, sometimes waiting months to see any money, Pancotti says. "They spent hours on the phone or refreshing web pages to collect benefits as state systems crumbled under the workload. Unfortunately for many of them, they weren't able to have taxes withheld from payments, and now they're facing four-digit tax bills as they struggle to keep the heat on or pay the rent."
Is there help on the way?
In addition to the taxpayers who opted into withholding, there are many who did not realize their unemployment benefits were taxable — about 39%, according to a recent Jackson Hewitt survey. There are likely millions of Americans who are facing major tax bills because of unemployment benefits this year.
Due to the scope of the issue, some federal and state lawmakers are attempting to step in to provide relief for those facing taxes on their unemployment benefits. Maryland and Delaware both recently passed legislation that waives state income tax on unemployment benefits for 2020. Additionally, a bill that would exempt unemployment benefits from taxes in 2020 and 2021 is awaiting a signature from Arkansas Governor Asa Hutchinson.
On the federal level, Senator Dick Durbin, D–Ill., and Rep. Cindy Axne, D-Iowa, re-introduced the Coronavirus Unemployment Benefits Tax Relief Act last month that would exempt the first $10,200 of unemployment compensation from federal income taxes in 2020.
A dozen members of Congress sent letters to Democratic leaders last week in support of including a tax waiver in the $1.9 trillion relief package, the American Rescue Plan Act. But the waiver did not make it into the House version of the bill passed on Saturday. The Rescue Plan package has been sent to the Senate, which is expected to make some modifications and pass the bill as early as this week.
Dealing with the fallout
It's worth noting that some taxpayers could see a reduction in their tax bill if they did not receive their second stimulus check, says Gerald Schreiber, a Louisiana-based certified public accountant. If you underpaid taxes on your unemployment benefits and never received your stimulus payments, those missing funds could be used to offset the balance due, Schreiber says.
If you're looking at a tax bill and aren't able to pay, you can request to be put onto a monthly payment plan, Schreiber says. If you opt for a short-term payment plan that's less than 120 days, there's no set-up cost, but penalties and interest, typically a 0.25% rate, do accrue. Keep in mind that's a lot less than it would cost to put that balance on a credit card for four months. Longer-term repayment plans are also available, but they come with additional fees.
At the end of the day, experts predict that millions of Americans could owe thousands of dollars to the IRS for taxes on their unemployment benefits. "There's just a lot of confusion about this all over the place — and the states add to the confusion," Schreiber says.