Unemployment reduces your refund because it counts as taxable income

Unemployment benefits are taxed as ordinary income by the federal government. When you receive them, they go into the total income the IRS uses to calculate how much tax you owe. If you did not have taxes withheld from your unemployment checks, you may owe money instead of receiving a refund — or your refund will be smaller than it would have been without the unemployment income.

The reduction happens because your total income went up. A larger income can push you into a higher tax bracket, meaning a bigger percentage of your money goes to taxes. It can also reduce or eliminate certain tax credits you might otherwise claim, like the Earned Income Tax Credit (EITC) or the Child Tax Credit. These credits phase out as income rises, so unemployment income can cost you money in two ways at once.

Key Takeaways

  • Unemployment benefits count as taxable income on your federal return, even though you may not have paid taxes on them when you received them.
  • You can choose to have taxes withheld from your unemployment checks when you first claim benefits, which reduces the tax bill later.
  • If you did not withhold taxes, you may owe money at tax time instead of getting a refund, or your refund will be smaller.
  • Some unemployment income may be excluded from your taxable income under specific rules, but this depends on the year and your circumstances.

Why unemployment income reduces refunds

The IRS treats unemployment as income because it replaces wages you would have earned. On your tax return, you report it on line 19 of Form 1040 (the main federal income tax form). This amount gets added to any other income you had — wages from a job, interest from a savings account, or self-employment income.

When your total income is higher, your tax liability (the amount you owe) goes up. If you had taxes withheld from paychecks during the year, those withholdings stay the same even though your income increased. The gap between what was withheld and what you actually owe becomes smaller, so your refund shrinks. In some cases, the gap closes entirely and you owe instead.

Unemployment also affects tax credits. The EITC, which can return hundreds or thousands of dollars to lower-income workers, begins to phase out at certain income levels. Adding unemployment income can reduce or eliminate this credit entirely. The same happens with the Child Tax Credit and other income-based credits.

Withholding taxes from unemployment checks

When you first file for unemployment, you can choose to have federal income tax withheld from your weekly or biweekly payments. This is optional — the state does not require it — but choosing it can prevent a large tax bill at the end of the year.

The withholding rate is flat: 10 percent of your unemployment payment. This is not the same as the tax rate you would pay on wages, and it may not be enough to cover your full tax liability. But it is better than having nothing withheld and discovering in April that you owe hundreds of dollars.

If you did not choose withholding when you filed, you may be able to change it mid-year. Contact your state unemployment office to ask whether you can request withholding on future payments. The process and timing vary by state.

Reporting unemployment on your tax return

Your state unemployment office sends you a Form 1099-G in January or early February. This form shows the total unemployment benefits you received in the previous year. You use this amount to fill in your tax return.

The 1099-G goes on line 19 of Form 1040. If you used tax software, it will ask you for this number and place it automatically. If you file by hand or with a tax professional, they will use the 1099-G to complete your return.

You must report all unemployment income shown on the 1099-G, even if you think some of it should not be taxable. If you believe part of your unemployment is not taxable under a specific rule (see the next section), you report the full amount first, then subtract the non-taxable portion on line 21 of Form 1040.

Unemployment income that may not be taxable

In some years and under specific circumstances, part of your unemployment benefits may be excluded from taxable income. This happened during the COVID-19 pandemic, when the federal government allowed people to exclude up to $10,200 of unemployment from their 2020 tax return.

These exclusions are temporary and tied to specific legislation. They are not permanent features of the tax code. Before claiming any exclusion, check the IRS website or speak with a tax professional to confirm whether an exclusion applies to your situation and the year you are filing for.

If an exclusion does explore, you report the full unemployment amount on line 19, then subtract the excluded amount on line 21 of Form 1040. This reduces your taxable income and may increase your refund or reduce what you owe.

What to expect at tax time

If you received unemployment and had no taxes withheld, prepare for the possibility that you will owe money rather than receive a refund. The amount depends on your total income for the year, your filing status, and whether you claim any dependents or credits.

If you owe, you can pay in full when you file, or you can set up a payment plan with the IRS. The IRS offers short-term plans (120 days or less) at no cost, and longer-term installment agreements for a small setup fee.

If you had some taxes withheld but not enough, you may still owe a smaller amount. If you had more than enough withheld, you will receive a refund even with the unemployment income included.

Planning ahead for next year

If you are currently receiving unemployment and expect to receive it again next year, consider requesting withholding on your payments. Even though 10 percent may not cover your full tax bill, it reduces the amount you will owe in April.

You can also estimate your tax liability using the IRS worksheet for unemployment income and adjust your withholding accordingly. If you have other income sources — a part-time job, a spouse's wages, or self-employment income — include those in your estimate as well.

Keeping track of your total income throughout the year, including unemployment, helps you avoid surprises at tax time. Many people find it useful to set aside a portion of each unemployment check to cover taxes, even if they do not request formal withholding.

Frequently Asked Questions

Will my unemployment reduce my child tax credit?

Yes, if your unemployment income pushes your total income above the threshold where the Child Tax Credit begins to phase out. The phase-out starts at $400,000 for married couples filing jointly and $200,000 for single filers. If your income is below these thresholds, your credit is not affected.

Can I get a refund if I received unemployment?

Yes, you can still receive a refund. Whether you do depends on your total income, your withholdings, and the credits you claim. If you had enough tax withheld from other sources (like a job) or if you claim credits that exceed your tax liability, you will receive a refund even with unemployment income included.

What if I received unemployment by mistake and have to pay it back?

If you repay unemployment benefits, you may be able to deduct the repayment from your income. The rules depend on how much you repaid and when. Consult a tax professional or the IRS website for guidance on your specific situation.

Do state taxes explore to unemployment the same way as federal taxes?

Most states tax unemployment income, but the rules vary. Some states do not tax it at all. Check your state's tax agency website or ask when you file for unemployment whether your state taxes these benefits.