Are You Penalized for Not Having Federal Taxes Withheld for Unemployment Benefits?

Even if you’ve lost your job, the Internal Revenue Service expects you to pay taxes on any money you bring in while you’re unemployed, including unemployment insurance benefits. You opt to have federal income tax withheld from your unemployment checks, just as your former employer withheld taxes from your paycheck, by filling out a voluntary withholding request. But this further reduces the benefit amount you bring home, at a time when you may need all the money you can get.

Some people elect to pay the taxes they owe at the end of the year when they file their tax return. Depending on your circumstances, you could end up owing a penalty to the IRS if you opt for this choice unless you take certain other steps.

Quarterly Tax Requirements

IRS rules require that anyone who expects to owe $1,000 or more in taxes for the year should pay quarterly estimated tax payments. These taxes are due on April 15, June 15, September 15 and January 15. If you don’t make these payments, the IRS can charge you a penalty for failing to pay your taxes.

The IRS supplies a worksheet, Form 1040-ES, to help you determine if you should pay quarterly taxes, and how much you should pay. If you’re unemployed for most of the year and have little other income, you should either have taxes withheld from your check or make quarterly payments, to avoid having to pay a penalty for not paying taxes on unemployment income.

Taxes on Unemployment Benefits

At the end of the year, the unemployment insurance office for your state will send you a Form 1099-G, which shows the total benefits you received during the year, as well as any taxes withheld from those benefits.

Report unemployment compensation on Line 19 of IRS Schedule 1 (1040), and add this amount to other income you may have listed on Lines 1 through 21. Total Lines 1 through 21, and enter this figure on Line 22. Transfer the total on Line 22 to Line 6 of your 1040, unless you have other adjustments to income, according to the directions for Schedule 1.

After taking any tax deductions to which you’re entitled, you figure the tax you owe on your adjusted gross income. Unless you were unemployed for only a short time, or you have a lot of deductions, you’ll probably owe taxes if you didn't opt for unemployment withholding from your benefit checks.

Alternatives to Quarterlies

If you don’t want to pay quarterly taxes and you don’t want to opt in for unemployment withholding, you have one other option. If you have a spouse who works and the two of you file as married filing jointly, you can opt to increase the amount of taxes withheld from her paycheck. The IRS looks at the total tax bill for a couple filing jointly, so as long as that total is equal to 90 percent of the taxes you owe for the year, or 100 percent of the taxes you paid last year, you won’t have to pay a penalty.

Other Tax Payment Considerations

If you live in a state that collects state income tax, you may need to make quarterly state tax payments to avoid a penalty from the state. If you elect to not have taxes withheld from your unemployment checks, make sure you have savings or other money set aside to pay your eventual tax bill.

Even if you elect to have taxes withheld, you may owe money at the end of the year; states withhold 10 percent of your check for taxes. If you earned enough income before your job loss, or if your spouse earns income, you may fall into a higher tax bracket and owe more taxes.