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Congress will soon be able to offer tax-free to unemployed Americans. States may not be so generous.
The Senate on Saturday approved a $ 1.9 billion Covid relief bill that waives taxes of up to $ 10,200 unemployment benefits per person received in 2020.
President Joe Biden is expected to sign the legislation this week after it was passed by the Democrats-led House of Representatives.
But the tax policy, which applies to households earning less than $ 150,000, is only a break from the federal income tax on workers.
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More than half of the countries levy an income tax on unemployment benefits. If Congress waives federal income taxes, states must decide whether they will also offer the break.
Some people still prefer to tax unemployment benefits, experts said.
As an example: Suppose a worker received $ 10,000 in benefits last year. That person still pays a $ 500 tax bill in countries with an income tax rate of 5% (if we accept a fixed tax rate).
“It’s complicated,” said Jared Walczak, vice president of state projects at the Tax Foundation. “Even many government officials are probably unsure about what will happen next.”
Taxes on the state
Federal policy is aimed at preventing a surprise tax bill for the unemployed.
About 40 million people received unemployment benefits last year, and the average person received $ 14,000 in aid, according to a report by The Century Foundation.
However, the report states that less than half of the recipients withheld taxes. In some cases, states did not offer the option.
But the relief bill is now changing the rules in the middle of the tax season, which begins on February 12 and ends on April 15.
This creates confusion for taxpayers, accountants and policymakers.
According to Walczak, thirty-five states and the District of Columbia usually tax unemployment benefits as income.
Three states – Maryland, Arkansas and Delaware – typically do this, but have waived taxes on benefits received in 2020.
The remaining states do not tax unemployment benefits because they do not have an income tax or are exempt from unemployment benefits.
State legislators must decide how to proceed, and their decision is time-sensitive. Many laid-off workers may wait to file their taxes until there is more clarity.
There is a precedent policy to waive taxes on unemployment income. In 2009, during the Great Recession, Congress passed the first $ 2,400 unemployment benefits from taxes, and many states followed suit, Walczak said.
However, the rule change did not take place during the tax season, he said.
‘Not easy’
Many state legislators may find it difficult to pass the change because they have already included tax revenue in the budget estimates for the current fiscal year, said Verenda Smith, deputy director of the Federation of Tax Administrators, who works with state tax officials.
States may have to withdraw money from other budget areas such as education to compensate, she said.
“It’s not easy to go along with this,” Smith said. “It’s a tough, tough budget decision they have to make.”
However, it will not be surprising if many states eventually adopt the federal tax policy, given the level of financial pain among Americans, she added.
According to Labor Department data, more than 18 million people are still benefiting from unemployment.
“On something like that, it pulls people’s heartstrings,” Smith said. “It will be very difficult for an elected official to vote against something like that.
“It’s just political reality,” she added.
Extensions and amended tax returns
It is likely that taxpayers who collected unemployment benefits last year and have already filed their tax returns will need to file an amended return in the future.
But they must wait to do so until the U.S. bailout plan becomes legal and there is more clarity from the IRS, the Treasury Department and respective states, experts said.
The IRS allows up to three years after the original filing date to submit an amended return and claim a refund.
According to experts, employees who have not yet submitted a return should consider applying for the extension of time.
If they do, they are not exempt from tax by the April 15 deadline. They have to owe taxes and pay to avoid fines.
But it allows extra time to see what state lawmakers and the federal government decide to do.
If the unemployment tax waiver becomes legal, those who file an extension could omit unemployment benefits (up to $ 10,200) from their income if they estimate their federal tax liability for 2020, according to Walczak.
But in countries that impose taxes on unemployment incomes and have not yet given guidance on new federal rules, workers should not deduct the benefits if they estimate taxes on the state, if they want to be conservative.