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IRS tax-free unemployment guidance: don't amend returns if you've already filed; use new worksheet if you haven't

Updated on March 21, 2021, to reflect that the IRS plans to automatically calculate any tax refunds due unemployment recipients who already filed their 2020 returns and paid taxes on their full benefits amount before the $10,200 tax exclusion was included in the American Rescue Plan Act (ARPA) enacted on March 11.

Updated on March 23, 2021, to reflect revised IRS changes to filing instructions in connection with ARPA's partial unemployment tax exclusion. The good news here is that the IRS now says those says jobless benefits you collected don't count toward the $150,000 income threshold that determines eligibility for this tax break. That means more taxpayers should qualify for the $10,200 tax exemption on unemployment.

Losing your job was bad enough. Then you had to deal with taxes on unemployment benefits. And now you have to work through a new law that at least makes some of the federal help tax-free.

If you're getting ready to file an amended tax return to account for the tax-free portion of unemployment benefits created by the American Rescue Plan Act's (ARPA), aka the latest COVID-19 relief bill that became law on March 11, don't.

The day after President Joe Biden affixed his signature to ARPA, the Internal Revenue Service issued a statement that essentially said whoa up.

"For those who received unemployment benefits last year and have already filed their 2020 tax return, the IRS emphasizes they should not file an amended return at this time, until the IRS issues additional guidance," said the IRS.

UPDATE, March 21, 2021: IRS Commissioner Chuck Rettig told a Ways and Means Subcommittee on March 18 that there is no need to file amended returns to get benefits of the ARPA's exemption of $10,200 in unemployment benefits. The IRS, said Rettig, will automatically issue refunds on tax-free unemployment to eligible early filers.

Sudden changes to sort through: The reason the federal tax agency wants us to take it slow is that it, like tax preparers and all us regular taxpayers, is still trying to sort through the bill and assess its immediate affects.

In that March 12 statement, the IRS says in addition to the unemployment tax change, the agency also is reviewing implementation plans for ARPA's economic impact payments and the expanded Child Tax Credit with its potential advance payments.

The unemployment tax break is one of the more clear-cut situations in ARPA.

Up to $10,200 in the federal out-of-work assistance received last year is tax-free if your If your modified adjusted gross income (MAGI*) is less than $150,000. Where married couples got unemployment, each spouse doesn't have to pay tax on up to $10,200 as long as the couple's income on their joint return is less than $150,000.

*Shameless plug for the ol' blog's glossary, which explains MAGI as well as many other tax terms.

Tax is still due on unemployment benefits in excess of $10,200. And if your MAGI is $150,000 or more, regardless of filing status, then you don't get any exclusion. Tax is due on all your unemployment compensation.

Taxpayers who've already filed their 2020 returns and paid tax on all their unemployment benefits understandably unhappy with the IRS instruction to slow down. By avoiding tax on a portion of unemployment, these early filers are looking at potentially lower tax bills or increased tax refunds.

Lots of tax-free unemployment: And there are millions of such taxpayers.

Data compiled by the U.S. Census Bureau show that in 2017, roughly 30 million adults lost jobs or saw their work hours reduced, either by their own or their employers' decisions.

Since unemployment benefits are paid only when a worker is involuntary terminated — that's government speak for fired —only about 3.8 million individuals collected unemployment insurance (UI), according to the Census' Survey of Income and Program Participation (SIPP).

Then along came the coronavirus pandemic.

From the start of the pandemic in March 2020 through February 2021, roughly four times the number of people, or 115 million, suffered a loss of work earnings. As a result, roughly 10 times the number of people, or 37 million, qualified for and received UI during that period, according to the Census' Household Pulse Survey.

There are no IRS figures to show how many of these more than 30 million taxpayers have already submitted returns. But it's a safe guess that some have. And now the IRS says to wait.

Peter J Reilly, CPA and Forbes columnist, thinks the IRS is using this breather to look into how it could take care of itself the already filed taxes that counted all unemployment payments.

"My money is that they will program things to make the adjustment automatically," writes Reilly. "They can likely do that more easily than processing many thousands of amended returns. We'll see."

New worksheet for those yet to file: What if you got unemployment last year and haven't yet filed your 2020 tax return. In these cases, the IRS says you can go ahead and submit your Form 1040.

But it wants you to do so using the updated instructions and the new Unemployment Compensation Exclusion Worksheet to figure your exclusion and the amount to enter on Schedule 1 (Form 1040), lines 7 and 8.

UPDATE, March 23, 2021: The IRS today updated its original updated instructions. The original IRS guidance issued on March 16 said to include unemployment income when calculating the $150,000 MAGI eligibility limitation. With these revised instructions for the unemployment compensation exclusion worksheet, the IRS has decided the MAGI limit that determines who gets the $10,200 tax-free unemployment benefits does NOT include unemployment compensation. That should make more filers eligible for the tax exclusion.

The Schedule 1 instructions now read:

Line 7
Unemployment Compensation

You should receive a Form 1099-G showing in box 1 the total unemployment compensation paid to you in 2020. Report this amount on line 7.

Caution: If the amount reported in box 1 of your Form(s) 1099-G is incorrect, report on line 7 only the actual amount of unemployment compensation paid to you in 2020.

Caution. When figuring any of the following deductions or exclusions, include the full amount of your unemployment benefits reported on Schedule 1, line 7 (unreduced by any exclusion amount): taxable social security benefits, IRA deduction, student loan interest deduction, nontaxable amount of Olympic or Paralympic medals and USOC prize money, the exclusion of interest from Series EE and I U.S. Savings Bonds issued after 1989, the exclusion of employer-provided adoption benefits, the tuition and fees deduction, and the deduction of up to $25,000 for active participation in a passive rental real estate activity. See the specific form or instructions for more information. If you file Form 1040-NR, you aren't eligible for all of these deductions. See the Instructions for Form 1040-NR for details.

Note. If your modified adjusted income (AGI) is less than $150,000, the American Rescue Plan enacted on March 11, 2021, excludes from income up to $10,200 of unemployment compensation paid to you in 2020. For married taxpayers, you and your spouse can each exclude up to $10,200 of unemployment compensation. For example, you file jointly with your spouse and your modified AGI is less than $150,000. You were paid $20,000 of unemployment compensation and your spouse was paid $5,000. Report the $25,000 (the total amount of your unemployment compensation) on line 7 and report $15,200 on line 8 as a negative amount (in parentheses). The $15,200 excluded from income is all of the $5,000 unemployment compensation paid to your spouse, plus $10,200 of the $20,000 paid to you. If your modified AGI is $150,000 or more, you can't exclude any unemployment compensation. Use the Unemployment Compensation Exclusion Worksheet to figure your modified AGI and the amount to exclude. If you file Form 1040-NR, you can't exclude any unemployment compensation for your spouse.

If you made contributions to a governmental unemployment compensation program or to a governmental paid family leave program and you aren't itemizing deductions, reduce the amount you report on line 7 by those contributions. If you are itemizing deductions, see the instructions on Form 1099-G.

Caution. Your state may issue separate Forms 1099-G for unemployment compensation received from the state and the additional $600 a week federal unemployment compensation related to coronavirus relief. Include all unemployment compensation received on line 7.

If you received an overpayment of unemployment compensation in 2020 and you repaid any of it in 2020, subtract the amount you repaid from the total amount you received. Enter the result on line 7. Also enter "Repaid" and the amount you repaid on the dotted line next to line 7. If, in 2020, you repaid more than $3,000 of unemployment compensation that you included in gross income in an earlier year, see Repayments in Pub. 525 for details on how to report the payment.

Tip. If you received unemployment compensation in 2020, your state may issue an electronic Form 1099-G instead of it being mailed to you. Check your state's unemployment compensation website for more information.

Unemployment Compensation Exclusion Worksheet – Schedule 1, Line 8

  1. If you are filing Form 1040 or 1040-SR, enter the total of lines 1 through 7 of Form 1040 or 1040-SR. If you are filing Form 1040-NR, enter the total of lines 1a, 1b, and lines 2 through 7.
  2. Enter the amount from Schedule 1, lines 1 through 6. Don't include any amount of unemployment compensation from Schedule 1, line 7 on this line.
  3. Use the line 8 instructions to determine the amount to include on Schedule 1, line 8, and enter here. Do not reduce this amount by the amount of unemployment compensation you may be able to exclude.
  4. Add lines 1, 2, and 3.
  5. If you are filing Form 1040 or 1040-SR, enter the amount from line 10c. If you are filing Form 1040-NR, enter the amount from line 10d.
  6. Subtract line 5 from line 4. This is your modified adjusted gross income.
  7. Is the amount on line 6 $150,000 or more?

    a. [ ] Yes. Stop You can't exclude any of your employment compensation
    b. [ ] No. Go to line 8

  8. Enter the amount of unemployment compensation paid to you in 2020. Don't enter more than $10,200.
  9. If married filing jointly, enter the amount of unemployment compensation paid to your spouse in 2020. Don't enter more than $10,200. If you are filing Form 1040-NR, enter -0- .
  10. Add lines 8 and 9 and enter the amount here. This is the amount of unemployment compensation excluded from your income.
  11. Subtract line 10 from line 3 and enter the amount on Schedule 1, line 8. If the result is less than zero, enter it in parentheses. On the dotted line next to Schedule 1, line 8, enter "UCE" and show the amount of unemployment compensation exclusion in parentheses on the dotted line. Complete the rest of Schedule 1 and Form 1040, 1040-SR, or 1040-NR.

Tax pro, software help: When did your eyes glaze over?

If you have a tax pro, s/he will take care of this for you.

If you use tax software, be sure to download the updates when you sign on to start or complete your 2020 return. The software manufacturers should have this revised information incorporated into their current filing programs soon.

But again, if you've already filed and included the jobless assistance, hang tight. Hopefully, the IRS will get back to us soon about next moves in these unemployment income tax return cases. See the March 21, 2021, update earlier in this post.

You also might find these items of interest:


Coronavirus Caveat & More Information
In 2021, we all still are dealing with extraordinary circumstances,
both in our daily lives and when it comes to our taxes.
The COVID-19 pandemic and efforts to reduce its transmission
and protect ourselves and our families means that,
for the most part, we're focusing on just getting through these trying days.

But life as we knew it before the coronavirus will return,
along with our mundane tax matters.
Here's hoping that happens soon!
In the meantime, you can find more on the virus and its effects on our taxes
by clicking Coronavirus (COVID-19) and Taxes.







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