If You Owe Taxes (Even if Unemployment Benefits Aren’t Taxed)
Do you owe 2020 income taxes even though the IRS is now not taxing the first $10,200 of unemployment income? What to do and not to do.
Last week we discussed the extent to which unemployment income is not taxed because of the American Rescue Plan Act. Generally, you don’t pay federal (and possibly state) income tax on the first $10,200 in benefits you received in 2020. Section 9042(a) of the Act. (See our last blog post about qualifying for this, and other details.)
Let’s get into two significant practical problems you may still have in spite of this substantial benefit:
You received more than $10,200 in unemployment benefits and so you owe income taxes on that extra amount.
You had other income separate from unemployment benefits and owe income taxes on that other income.
You owe income taxes for prior tax years. So now you’re afraid of filing the 2020 tax returns and having the IRS/state start to chase you down.
We’ll discuss the first two of these situations today, the third one a week from now.
1. More Than $10,200 in 2020 Unemployment Income
If you were unemployed for a substantial part of 2020 you may well have accrued more than $10,200 in unemployment income. That’s especially true if you qualified for the additional $600 per week (later reduced) in extra federal pandemic unemployment income. Note that the income exclusion applies to both state and federal unemployment benefits. U.S. Dept. of Treasury Fact Sheet, March 18, 2021 (see final paragraph). So they can add up fast is you were unemployed for an extended time.
Regarding this, first realize that for joint filers you’re EACH entitled to the $10,200 income exclusion. BUT, you can’t just double the excluded amount to $20,400 if you’re filing jointly; each spouse has a $10,200 maximum. IRS Post Release Changes to Forms, New Exclusion of up to $10,200 of Unemployment Compensation. For example, assume you had $15,000 and your spouse had $5,000 in the unemployment income, totaling in $20,000. In the joint return you wouldn’t be able to exclude all $20,000. You could exclude just $10,200 of the $15,000, while your spouse could exclude all $5,000, a total of 15,200. That means that $3,800 of your benefits would be federally taxable (and likely by your state, too).
Second, just because you have taxable unemployment income (the $3,800 in the above example), doesn’t necessarily mean you’ll owe taxes. There are countless considerations determining whether you’d actually owe tax if you have a relatively low amount of taxable income. One important consideration is that the standard deduction in 2020 for individuals is $12,400, $24,800 for those filing jointly. IRS News Release, IR-2019-180. Your applicable standard deduction (or itemized deductions) may more than cover any non-excluded unemployment income.
However, after all is said and done you may find out that you do owe federal income taxes. And possibly state income taxes as well. See below, after the next section, for more about what to do then.
2. Owe Tax on Other 2020 Income
Let’s say you did have unemployment income in 2020 and it was all covered by the $10,200 federal exclusion. But you had other taxable income for which you did not withhold or pay any (or enough) estimated taxes.
Similar to what we stated above, you may still not owe any federal income taxes because of other considerations. (As just one example, the stimulus (“Economic Impact”) payments are not taxable income. IRS Tax Tips, May 12, 2020.) So you absolutely should prepare your tax returns or have them prepared for you. Do not live in fear; as the saying goes, it is better knowing rather than not knowing. This is especially true if 2020 was different for you financially than prior years. It sure has been different for just about everybody! You might be pleasantly surprised that you don’t owe, or that you owe only a modest amount.
If You Still Owe 2020 Income Tax
So you do prepare your 2020 tax returns and find out you owe regardless of the $10,200 unemployment income exclusion. What now?
Let’s say the tax owed is quite modest, but still too much to pay in a lump sum. The most sensible solution might be to apply online for an IRS payment plan. One advantage is you don’t need to talk to anyone—it’s all online. Plus they have a lower fee than other options. Both individual and business taxpayers can qualify. There are short term (120 day) and long-term monthly plans available. The long-term plans are not expensive: $31 for individuals—potentially waivable for low income—and potentially that low for businesses. However, interest and penalties continue to accrue and can add up quickly.
But what if the tax owed is more than you can afford to pay monthly on an IRS payment plan? You may have no room whatsoever in your monthly budget to pay the IRS anything. Or you may owe more to the state taxing authority (especially if it’s fully taxing your unemployment) and have no money to pay it.
Maybe you’ve never been behind on income taxes. So you are understandably worried about having the IRS and maybe also your state chasing you. Or you have some experience with the federal and state taxing authorities and know something about their collection powers. Either way, you’re justifiably concerned.
Don’t Avoid Sending in the Tax Returns
If you owe income taxes don’t do what may feel tempting: not submitting the tax return when it’s due. You might think you’ll buy some time by laying low. You figure if they don’t know you owe, they won’t start chasing you for it. It’s all too human to hide from something that’s scary, especially when there seems to be no practical solution.
But you’ll pay a very heavy price for the time you think you’re buying. There are a series of penalties by the IRS (and by your state) for failure to timely file income tax returns. For individuals there’s a flat $435 starting failure-to-file fee (for returns due starting 1/1/2020). In addition there are significant steep penalties for each month you don’t file. On top of that there are monthly penalties for the failure to pay the amount due.
So almost certainly you want to submit the tax returns when they are due.
Get Good Guidance
However, both for practical reasons and for your mental health you’d be wise to get some guidance about your options. And common sense says you should get that guidance before you submit the returns.
Let’s face it. If you cannot afford to pay the IRS (and/or state) monthly payment plan, most likely you’re in broader financial trouble. You likely have more than one high-priority debt that you’re trying to juggle. This new debt to the IRS/state is a sign that you need to find out your legal options.
Without going into greater detail here, you likely do have some sensible options. For example, it may be worth getting rid of other debts through a Chapter 7 “straight bankruptcy.” Then you could much better afford to pay your income tax debts. Or you may have other competing special debts—like a mortgage or vehicle loan in arrears, or child/spousal support. A Chapter 13 “adjustment of debts” would protect you from all these especially powerful creditors.
See more information about these options elsewhere in this website. And call us, your bankruptcy lawyers, for some good guidance about your options, bankruptcy or otherwise.