Tax Refunds for Those with Unemployment Income
When COVID-19 hit, the subsequent economic fallout also hit hard. Despite government incentives that aimed to keep people employed, successfully I might add, millions of Americans still were suddenly out of work and found themselves relying on and receiving state and federal unemployment benefits.
As if times weren't hard enough, current federal tax law treats unemployment benefit as taxable income upon which income tax must be paid. Many states, including Arkansas, likewise normally tax unemployment income.
Realizing the hardship this was causing, as part of the government's efforts to stabilize the economy and more basically, help the unemployed pay their bills, Congress included a provision in the American Rescue Plan Act (ARPA) which exempts unemployment benefits received in 2020 from income tax, up to a maximum of $10,200 ($20,400 for a married couple) in total benefits for households with adjusted gross income of less than $150,000 in 2020. The Arkansas legislature passed a similar act, signed into law by the governor, that exempts not only 2020 benefits but also 2021 amounts received.
The problem is, ARPA was passed and signed into law in March 2021, well after the tax filing season for 2020 returns had already begun. By that time, millions of us had already filed 2020 income tax returns, including unemployment benefit recipients who effectively paid tax on what was now tax-exempt income. Not to mention the fact that the IRS now had to retool its systems and tax software providers reprogram software to take into account the retroactive change.
As a tax professional, my first reaction was that it looked like we were going to need to file a bunch of amended tax returns to take advantage of the change, of course, waiting until the systems and software caught up. Refunds from amended tax returns are notoriously slow in coming, so this thought was very palatable.
Fortunately, in rides the IRS to the rescue (never thought I would hear myself say that)!
Once it got its bearings, the IRS said that it would begin reviewing tax returns that were filed showing unemployment income as taxable, would recalculate the tax treating the benefits as tax-exempt, and then would automatically issue refunds to affected taxpayers. It took a while, but the IRS has finally begun to issue these refunds.
The IRS says it has identified 10 million taxpayers that filed tax returns before the law change and could be due a refund, and so far has sent money to roughly 2.8 million of those affected. It expects to issue more refunds this week, and will continue throughout the summer until all affected taxpayers have received anything due them as a result of the law change.
Refunds will be issued by direct deposit to taxpayers who have previously provided their bank account information to the IRS, while others will receive a paper check in the mail, which of course will take a bit longer.
The IRS also says it will send you a notice explaining any corrections made. You can expect to receive the notice within 30 days of when the correction is made. You should keep any notices you receive for your records, and make sure you review your return after receiving an IRS notice. They do sometimes make mistakes, so don't just assume they are correct.
Also, there could be other reasons you may still need to file an amended return. For example, the reduction in taxable income due to the unemployment tax exemption could cause some taxpayers to qualify for the earned income tax credit that didn't before. The IRS may not catch this, so you could be entitled to even more to be refunded to you in this or other situations.
One final thought; as already mentioned, the federal exemption from tax only applies to the 2020 tax year, so if are still receiving unemployment in 2021, as of now it will be taxed. You may want to consider whether you should have income tax withheld currently from your benefits to cover that tax.
