Congressional Research Service: 'Taxing Unemployment Insurance Benefits – Federal- & State-Level Tax Treatment During COVID-19 Pandemic'
Here are excerpts:
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SUMMARY
Unemployment insurance (UI) benefits have generally been fully subject to federal income taxation since the Tax Reform Act of 1986 (P.L. 99-514). For federal income tax purposes, UI benefits include regular state Unemployment Compensation (UC), Extended Benefits (EB), Trade Adjustment Assistance (TAA) benefits, Disaster Unemployment Assistance (DUA), railroad unemployment benefits, and all temporary UI benefits created in response to recessions (such as the now-expired COVID-19 UI benefits). A special provision allowed up to
This report describes the federal taxation of UI benefits, including federal income tax withholding requirements related to the now-expired COVID-19 UI benefits. It also provides
The report uses data collected by
This report also explains the federal income tax exclusion authorized for UI payments made in 2020. The American Rescue Plan Act of 2021 (P.L. 117-2) allowed taxpayers with modified AGI of less than
Finally, this report summarizes state income tax treatment of UI benefits, including whether a state offers to withhold state income taxes from UI benefits and the state's withholding rate. Most states that have state income taxes include UI benefits in taxable income, and many of them offer state income tax withholding to UI claimants. Many states that tax UI benefits also provided a temporary tax exclusion for these benefits in 2020 similar to the temporary federal exclusion. A few states have extended this option for the 2021 tax year.
For more information on UI benefits, including the now-expired COVID-19 UI benefits, see CRS Report R46687,
For the legislative history on the taxation of UI benefits, see CRS Report RS21356, Taxation of Unemployment Benefits.
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Contents
Introduction ... 1
UI Benefits: the COVID-19 Pandemic Response ... 1
UI Benefits: Taxable Income Under Federal Tax Law ... 3
UI Replacement Rates ... 4
Federal Income Tax Withholding from UI Benefits ... 5
Federal Tax Withholding: Pandemic-Related Benefits ... 5
Data on UI Income from Federal Income Tax Returns ... 6
Amount of UI Benefits Withheld for Federal Income Taxes in 2020 and 2021 ... 7
Temporary Federal Income Tax Exclusions for UI Benefits ... 8
Temporary Tax Exclusion Does Not Apply to 2020 Benefits Paid in 2021 ... 9 State Income Tax Withholding of UI Benefits ... 9
State Tax Responses to the Federal 2020 UI Benefit Exclusion ... 11
Tables
Table 1. Tax Returns with Reported Unemployment Insurance Income, Tax Year 2019 ... 7
Table 2. General State Income Tax Treatment of UI Benefits and Withholding Rate ... 9
Table 3. State Income Tax Exclusion of UI Benefits in 2020 and 2021 ... 11
Contacts
Author Information ... 13
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Introduction
The COVID-19 UI benefits authorized from
This report provides information on the federal taxation of UI benefits, including federal income tax withholding requirements related to the now-expired COVID-19 UI benefits. The report also discusses the federal income tax exclusion authorized for UI payments in 2020, which allowed taxpayers with modified adjusted gross income (AGI) of less than
UI Benefits: the COVID-19 Pandemic Response
The UI system's two main objectives are to provide temporary and partial wage replacement to involuntarily unemployed workers and to stabilize the economy during recessions. The two permanent-law UI benefits--Unemployment Compensation (UC) and Extended Benefits (EB)-- are countercyclical, with spending and weekly benefit payments that increase automatically during a recession.
In response to the recent recession/2 and the economic disruption caused by the COVID-19 pandemic,
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1 For pre-2020 temporary UI benefit expansions, see CRS Report RL34340, Extending Unemployment Compensation Benefits During Recessions.
2 The
3 For details on these temporary programs, see CRS Report R46687,
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The programs included the following:
* Federal Pandemic Unemployment Compensation (FPUC) first provided a temporary, additional
* Pandemic Emergency Unemployment Compensation (PEUC) provided a total of 49 additional weeks of federally financed UI benefits at an amount equivalent to regular state UI benefits for individuals who exhausted state and federal UI benefits and were able to work, available for work, and actively seeking work, subject to COVID-19-related flexibilities, from
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4 Permanent-law UC benefits are financed by the states; under permanent law, the EB program is financed 50% by the states and 50% by the federal government.
6 These included regular UC, Pandemic Unemployment Assistance (
8
10
12
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* Pandemic Unemployment Assistance (
The Continued Assistance Act authorized an additional, temporary UI benefit:
* Mixed Earner Unemployment Compensation (MEUC) provided, at state option, a
Additionally,
* Lost Wages Assistance (LWA) was paid as a
UI Benefits: Taxable Income Under Federal Tax Law
UI benefits have been fully subject to federal income taxation since 1987./19 The two underlying rationales for fully subjecting UI benefits to income tax are (1) to treat the benefits the same as wages and (2) to eliminate the work disincentive caused by the previously favorable tax treatment for UI benefits relative to wages./20 This federal tax treatment means unemployment benefits are treated the same as wages and other ordinary income with regard to federal income taxes.
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13
14
15
16
18 LWA was potentially available for weeks of unemployment between
19 As required under the Tax Reform Act of 1986 (P.L. 99-514, enacted
20
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However, UI benefits are not subject to payroll taxes, including
For the purposes of federal income taxation,/22 the definition of UI benefits includes regular state UC benefits, EB,/23 Trade Adjustment Assistance (TAA) benefits,/24 DUA,/25 and railroad unemployment benefits,/26 and has included all temporary UI benefits (e.g., FPUC, PEUC,
UI Replacement Rates
Most state UC benefit calculations generally replace half of a claimant's average weekly wage up to a weekly maximum (cap) for up to 26 weeks./29 Before the COVID-19 pandemic, the average ratio of UI benefits to prior earnings generally ranged from 30% to 50%./30 In general, workers with higher earnings would have lower replacement rates than average in state UC calculations, in part because of the cap on maximum benefits.
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21 For more information on payroll taxes, see CRS Report R47062, Payroll Taxes: An Overview of Taxes Imposed and Past Payroll Tax Relief .
22 For the full definition of UI benefits under tax law, see 26 U.S.C. Section 85. See also 26 C.F.R. Sec.1.85-1.
23 For more information on UC and EB, see CRS Report R46687,
24 For more information on TAA, see CRS In Focus IF10570, Trade Adjustment Assistance for Workers (TAA).
25 For more information on DUA, see CRS Report RS22022, Disaster Unemployment Assistance (DUA).
26 For more information on railroad unemployment benefits, see CRS Report RS22350, Railroad Retirement Board: Retirement, Survivor, Disability, Unemployment, and Sickness Benefits.
27 For more information on historical, temporary UI benefits created by
28 Table 2, below, provides detailed information on how states treat UI benefits in their state income tax systems.
29 Although there are broad requirements under federal law regarding UC and EB benefits and financing, the specifics are set out under each jurisdiction's laws, resulting in 53 different UC programs operated in the 50 states, the
30 For a summary of each state's benefit calculation, see Table 3-5 "Weekly Benefit Amounts" in DOL, Comparison of State Unemployment Insurance Laws, Chapter 3. Monetary Entitlement,
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Weekly UI benefits in 2020 and 2021 often provided significantly higher levels of gross income replacement than had previously been the case, as the underlying UI benefit was augmented by temporary measures (e.g., the
Federal Income Tax Withholding from UI Benefits
Since 1997, state UI agencies, which administer all UI benefits, have been required to offer claimants receiving regular UC the opportunity to elect federal income tax withholding at the time the claimant first files for UC benefits./33 The option, if selected, must continue onto other UC-based benefits (e.g., EB). Additionally, states are required to inform beneficiaries that state UC and EB payments are included in their gross income for federal income tax purposes and that they will receive
Under federal tax law, the current withholding rate for federal income tax is 10% of the gross UI payment. The 10% rate applies to all filing statuses - single, married filing jointly, married filing separately, head of household - and is not conditional on the number of dependents. Typically, this low withholding rate would be sufficient to cover federal income tax liability for most unemployed individuals, as they would be expected to have significantly lower income (due to job loss and the average 30%-50% replacement rate of UI). However, it may not have been sufficient when an individual's UI income replacement was greater than their pre-pandemic earnings (as was the case for a period in 2020--as discussed above in the "UI Replacement Rates" section). As a result, during the periods when FPUC, MEUC, and LWA were supplementing UI benefits, individuals with lower earnings histories may have been subject to a higher federal income tax bracket in which the 10% withholding rate might have been insufficient to prevent additional federal income tax being due.
Federal Tax Withholding: Pandemic-Related Benefits
Withholding requirements varied across the different pandemic-related UI programs.
* PEUC: States were required offer PEUC recipients the opportunity to elect federal income tax withholding. DOL applied 26 U.S.C. Section 3304(a)(18) to PEUC based on Section 2107(a)(4)(B) of the CARES Act, which required the application of state and federal UC laws to PEUC claims and payments to the extent practicable./34
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31
32 Ibid., Figure 3.
33 26 U.S.C. Sec.3304(a)(18). Claimants who elect to have federal income tax withheld from their regular UC (and EB) benefits must file
34 Information provided by email communication from DOL, ETA to CRS on
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*
* FPUC and MEUC: States were required to offer individuals receiving FPUC (and MEUC if applicable) the opportunity to withhold federal taxes./36 There is some indication that not all states were able to meet this requirement./37
* LWA: States were required to notify individuals that LWA payments were subject to federal income taxation but were not required to provide them with the option to withhold federal income taxes from LWA payments./38
Data on UI Income from Federal Income Tax Returns
The
Of returns reporting UI payment income, approximately 30% (1.29 million) were not taxable and reported 26.2% of all UI payments. Taxpayers in this group did not owe income taxes and paid no taxes on their UI benefits for tax year 2019.
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35 DOL, ETA, "Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 - Pandemic Unemployment Assistance (
36 DOL stated that 26 U.S.C. Section 3304(a)(18) also applied to FPUC and MEUC; information provided by email communication from DOL, ETA to CRS on
37 For example, according to the
Also see
38
39 For more information on the
40
41 For 2019, an estimated 157,769,807 returns were filed (
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Overall, among individuals with UI-covered job losses, an estimated 49.0% of UI income was received by tax filers with an AGI of less than
An estimated 21.0% of UI income went to tax filers with an AGI of at least
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Table 1. Tax Returns with Reported Unemployment Insurance Income, Tax Year 2019
Source: Created by CRS using
Notes: AGI is total income minus statutory adjustments. Data are
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42 States are prohibited from restricting UI benefit eligibility based upon an individual's or household's income level because of a 1964 DOL decision that precludes states from means-testing to determine regular UC eligibility; see Letter from
43 Although the above 1964 decision directly pertains to the UC program, all other UI programs except for Disaster Unemployment Assistance (DUA) use the same eligibility requirements.
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Amount of UI Benefits Withheld for Federal Income Taxes in 2020 and 2021
UI program data provide information on taxes withheld from UI benefits for 2020 and 2021. According to
Temporary Federal Income Tax Exclusions for UI Benefits
Since it began to treat all UI benefits as fully taxable income,
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44 CRS calculations of ETA 2112 data extracted on
45 In 2019, a total of
46 In 2020, a total of
47 See footnote 35. Additionally, see "Why were you not able to withhold taxes from the
48 The
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The legislative intent of the exclusion was to mitigate unexpected taxes due to the
Temporary Tax Exclusion Does Not Apply to 2020 Benefits Paid in 2021
One question regarding the 2020 exclusion relates to circumstances in which UI benefit payments are delayed. UI benefit payments might be delayed for a variety of reasons, such as state administrative delays and claimant appeals. The
State Income Tax Withholding of UI Benefits
Most states have some form of personal income taxation (eight do not). In states with personal income taxation, five do not consider UI benefits taxable income./52 Federal law allows but does not require states to offer to withhold state income taxes from UI payments. Table 2 provides information on state tax treatment of UI benefits, including whether the state offers to withhold state income taxes from UI benefits and the state's withholding rate.
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Table 2. General State Income Tax Treatment of UI Benefits and Withholding Rate
Source: Created by CRS. Underlying citations are available to congressional clients upon request.
a. Beginning in 2021, UI benefits are exempt from taxation in the
b. State has a UI exemption if a taxpayer's federal AGI is under
c. The beneficiary's choice must be a whole percentage (e.g., 2.0% not 2.1%).
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49 Section 9042 of ARPA was based on S. 175 and H.R. 685 (117th
50 The
51 See A6 of
52
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State Tax Responses to the Federal 2020 UI Benefit Exclusion
When the temporary
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Table 3. State Income Tax Exclusion of UI Benefits in 2020 and 2021
Source: Created by CRS. Underlying citations are available to congressional clients upon request.
a.
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53 Government of the
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The report is posted at: https://crsreports.congress.gov/product/pdf/R/R47105
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