While many never lost their jobs this year, 30 to 40 million Americans either lost their jobs or had serious financial setbacks because of the COVID-19 pandemic. Approximately 20 million Americans took state unemployment benefits besides the $600 per week millions of Americans received for several months this year. Almost all Americans received a onetime taxpayer funded $1,200 check from the federal government, which will show up as a tax credit for your 2020 federal income taxes.
First, the $1,200 tax credit is a wash for almost all who received it. Most will not need to pay anything more, nor will they be getting money back because of receiving the $1,200 onetime payment. The $1,200 does not count as income for your taxes.
While a few states in the Union exempt unemployment income from state income taxes, it is taxable for federal income taxes. When one signs up for unemployment, you can have federal income taxes withheld similarly, as one would when working for an employer. Although it should be on their state’s website, unemployment recipients can fill out form W-4V and submit it to their state’s unemployment office to have taxes (10 percent) withheld from each distribution.
In January 2021, unemployment recipients will receive a form 1099-G showing how much taxpayer-funded income they received and will help them figure out how much they are going to owe Uncle Sam on April 15, 2021. If recipients filed form W-4V with their state unemployment office, then Box 4 of form 1099-G will show how much federal tax was withheld from their payments.
Since every taxpayer’s situation differs from their neighbor’s federal income tax obligation, it may be beneficial to use the IRS Tax Withholding Estimator. This handy tool will help taxpayers get an estimate of what their federal income tax obligation will be, and there is still time to minimize that obligation. Many Americans could be on the hook for between $3,000 to $5,000 due on April 15, 2021. So, whereas many taxpayers are accustomed to not paying anything or receiving a refund on the federal income taxes on April 15, 2020, as they usually pay their federal income tax obligation with each paycheck, 2021 may be different for many.
Some ways to thwart or dramatically reduce one’s federal tax obligation is to start a side business, but only if you can show loss on the business (at least for this year). Starting a business may or may not help you based on your personal tax situation, so it is best to speak with a tax advisor, but in most situations it helps. Other ways to reduce your federal tax obligation is to contribute to an IRA (traditional or IRA) or HSA plan, contribute to a 401(k) plan, if you have enough itemized deductions, then itemize rather than take the standard deduction, buy an electric car, plug-in hybrid car, and/or add solar panels to your roof to get a tax credit, pay your state income and property taxes early to offset your taxable income, and use whatever other tax credits are available under your particular circumstances.