With so many people finding themselves out of work and trying to make ends meet due to COVID-19, unemployment benefits are helping many to supplement the loss of wages. When filing for unemployment benefits, many people choose not to have federal or state tax withheld. Having no taxes withheld means the weekly amount received is larger and allows you to have more money in your pocket now. It can create an issue later when filing your taxes in the following year.
Some taxpayers believe that unemployment benefits are not taxable. Unemployment benefits are not subject to Medicare or Social Security tax. They are taxable for federal income tax purposes, just like wages. Some states like New York also tax unemployment benefits while others like Pennsylvania do not.
After collecting unemployment benefits with no taxes withheld, many are surprised to find out there is a balance due or their refund is significantly reduced when they file their taxes. If you do not have the funds to pay the balance due, this can create a problem for you. There is also possible penalties and interest due on the balance owed, creating an even more significant financial hardship.
You can have a maximum of 10% federal tax withheld on unemployment benefits. For many, this is not enough and they will still find themselves with smaller refunds or a balance due. Even if this withholding is not enough, it will reduce the balance due or take less of a bite out of your refund if you have the 10% withheld.
You can set up an installment agreement to pay the balance due over time if you find yourself with a balance due. When you enter into an installment agreement, you must stay current with all future taxes while on installment. There is a one-time setup fee when you enter into an installment agreement. Depending on how you apply and if you qualify for the low-income reduction, the fee ranges from $31 to $225.
You will also be charged interest daily on the balance until it is paid in full. Currently the interest rate on an installment agreement is 3%. People often ask if they should put the outstanding balance on a credit card to get it paid off. Ask yourself this question – what is the interest rate on the credit card? Is it 3% or less? Entering into an installment agreement typically means that you are going to pay less in interest than if you put the balance on a credit card and pay that interest rate.
Unemployment benefits are not meant to replace 100% of wages lost. What can you do to make ends meet while collecting? First, have taxes withheld to reduce your burden at tax time. Second, look at your current spending and figure out where expenses can be reduced or cut. Start with luxuries like entertainment, dining out, cable/tv, internet, cellphone, etc. These expenses do not need to be cut completely. Work with your providers to reduce the bills where possible. Do you really need all those movie channels, or could you get by with basic cable while income is reduced? Do you really need to pay for extra cloud storage for your cellphone? Can you reduce your grocery bill by purchasing more items that are generic? By sitting down and taking a good look at your bills, can you reduce expenses and help make your unemployment benefits go further?
Reducing expenses and having taxes withheld from your unemployment benefits can reduce the length of the hardship when you return to work. It can take a significant amount of time to recover from being unemployed when you need to pay down high credit card balances or a large balance to IRS after going back to work. Small changes can have a tremendous impact on your budget and help make your money go further and reduce the stress experienced during financial hardship. Remember, every little change can help!
