Americans won’t pay 2020 income tax on up to $10,200 of unemployment funds

If you got unemployment during 2020, you might expect Uncle Sam to ask for some federal taxes.

Not so this year.

The Internal Revenue Service issued instructions that up to $10,200 of unemployment benefits won’t be taxed. That’s because the Biden Administration’s $1.9 trillion American Rescue Plan excluded that sum for the 2020 tax year.

This tax season is shaping up to be bizarre. The final rules are still in flux. Accountants lack all the answers. And even some commercial filing software hasn’t been fully updated.

Take those who already filed returns, and included tax payments for unemployment. The IRS is advising those taxpayers not to do anything yet until they have updated the rules.

It could take the federal government tax agency 30 to 45 days to reprogram computer systems to account for the American Rescue Plan.

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That adds a new level of complexity to taxes, said Philadelphia accountant Steve Ramm.

Consider waiting until tax software has been updated and the IRS website too, he advised.

There’s even talk of extending the April 15 tax deadline this year, as was done in 2020.

Unemployment benefits have been taxable since the 1980s. However, the explosion of pandemic-era unemployment, plus with the arrival of the new stimulus bill, have created a massive tax mash-up for Americans in 2020.

The $10,200 income exclusion is intended to cover 17 weeks of the $600 federal benefit passed under last spring’s Coronavirus Aid, Relief & Economic Security (CARES) Act.

“From rebates to tax credits, there is a lot to unpack,” said Julio Gonzalez, CEO of Engineered Tax Services in West Palm Beach, Fl. He helped advise on the 2017 Tax Cuts and Jobs Act, working with Congress on tax reform.

“There is so much more in this [relief] bill that many Americans do not yet know about, or how to best utilize.”

It is not clear if those who already filed 2020 returns will now have to file amended returns or if the IRS will adjust the returns for them automatically, accountants said.

There is a worksheet that the IRS is developing to calculate the amount of unemployment that is taxable.

But “these calculations are very complex,” said David Zalles, a CPA in Blue Bell, Pa.

For example, the IRS calculates the tax exemption based on “modified” Adjusted Gross Income.

This is important for taxpayers who are self-employed, sole proprietors, or independent contractors. These folks can adjust for 50% of their self-employment tax, health insurance premiums (including Medicare for taxpayer and spouse), and IRA, SEP, SIMPLE, and solo 401-K retirement plan contributions, Zalles said.

Other adjustments allowed for all taxpayers include student loan interest (up to $2,500).

Tax professionals will have to determine if savings are greater filing separate or joint tax returns for married folks, “which until now has been beneficial in most cases,” Zalles said.

Now comes the third round of stimulus/economic impact payments.

Didn’t get the first and second payments? You can claim the 2020 Recovery Rebate Credit. But you must file a 2020 tax return even if you don’t normally file.

Visit the IRS website to claim your 2020 Recovery Rebate Credit. For the latest updates, check IRS.gov/coronavirus.

Under the American Rescue Plan, the third round of payments total $1,400 per adult, and $1,400 per dependent, which includes children over 17, and even dependent older parents. Individuals who earn $75,000 or less are slated to receive $1,400, and couples making $150,000 or less will be paid $2,800.

To check if your money’s coming, visit the IRS “Get My Payment” link: www.irs.gov/coronavirus/get-my-payment.

Payments are to be mailed out or deposited starting this week, and that money is not taxable.

“I have no idea if these are initially only to taxpayers who had entered their bank account information on their 2019 tax returns, or if they will be direct depositing to bank accounts for Social Security recipients,” Zalles said. “Also, people who filed their 2020 tax returns already should not expect that the IRS will update their records for bank information on those 2020 tax returns.”