Unemployment Compensation Benefits and Your Taxes (2024)

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By A. Kalman, AARP

In 1935, during the Roosevelt administration, Congress passed the the Social Security Act. Buried in that law was the creation of the federal – state unemployment compensation program. By the end of 1936, 35 states and the District of Columbia had passed unemployment compensation laws. Shortly thereafter, the remaining 15 states came on board. That program with some modification is still in place today. It provides benefits that are on the average 50% of a worker’s pay prior to being laid off from work. It may come as a surprise to some workers, but unemployment compensation from your state is taxable gross income. In fact, there is a specific line on the 1040, 1040A and 1040EZ forms for you to add the amount to gross income. In January of each year, your state will send you and the IRS, Form 1099-G that reflects the amount of benefits paid during the year.

Unemployment compensation is not wages and therefore, there is no social security or medicare tax withheld from the payment. As it is not wages, it is also not earned income. As such, you can not use unemployment compensation to obtain the Earned Income Tax Credit. Most states will not withhold any income tax from these benefits unless you specifically request voluntary withholding. Many taxpayers may find themselves owing tax they don’t have or that they should have been making quarterly estimated tax payments. You can find more information on this subject in IRS Tax Topic 518.

If you have a dependent child that may have been working and was laid off and is eligible for unemployment compensation benefits, there is a risk that your child may be subject to what many refer to as the “Kiddie Tax” (tax on a child’s investment income). This happens when a dependent child has investment income in excess of $1,900 and will be taxed at the parent’s tax rate. Most of us typically think of investment income as being income from interest, dividends and capital gains sourced from investment property. When it comes to the Kiddie Tax, it includes just about all unearned income the child receives, including, you guessed it, unemployment compensation. When this happens, the child’s tax return cannot be prepared until the parent’s return is finished. For more information on a child being taxed at the parent’s rate see IRS Tax Topic 553.

In 1935, during the Roosevelt administration, Congress passed the the Social Security Act. Buried in that law was the creation of the federal – state unemployment compensation program. By the end of 1936, 35 states and the District of Columbia had passed unemployment compensation laws. Shortly thereafter, the remaining 15 states came on board. That program with some modification is still in place today. It provides benefits that are on the average 50% of a worker’s pay prior to being laid off from work. It may come as a surprise to some workers, but unemployment compensation from your state is taxable gross income. In fact, there is a specific line on the 1040, 1040A and 1040EZ forms for you to add the amount to gross income. In January of each year, your state will send you and the IRS, Form 1099-G that reflects the amount of benefits paid during the year.

Unemployment compensation is not wages and therefore, there is no social security or medicare tax withheld from the payment. As it is not wages, it is also not earned income. As such, you can not use unemployment compensation to obtain the Earned Income Tax Credit. Most states will not withhold any income tax from these benefits unless you specifically request voluntary withholding. Many taxpayers may find themselves owing tax they don’t have or that they should have been making quarterly estimated tax payments. You can find more information on this subject in IRS Tax Topic 518.

If you have a dependent child that may have been working and was laid off and is eligible for unemployment compensation benefits, there is a risk that your child may be subject to what many refer to as the “Kiddie Tax” (tax on a child’s investment income). This happens when a dependent child has investment income in excess of $1,900 and will be taxed at the parent’s tax rate. Most of us typically think of investment income as being income from interest, dividends and capital gains sourced from investment property. When it comes to the Kiddie Tax, it includes just about all unearned income the child receives, including, you guessed it, unemployment compensation. When this happens, the child’s tax return cannot be prepared until the parent’s return is finished. For more information on a child being taxed at the parent’s rate see IRS Tax Topic 553.

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