Unemployment Benefits + Income Tax: Everything You Need to Know

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A key element of the CARES Act was the ability for the self-employed to apply for unemployment benefits under the Pandemic Unemployment Assistance (PUA) program. However, what may not be clear to many self-employed people who are receiving unemployment payments, often for the first time in their working lives, is that this income is taxable—freelancers will need to factor this in when making estimated tax payments and calculating their annual income tax obligations.

Another key point to remember about any unemployment payments you may have received is that, depending on where you reside, they may be subject to not only federal income taxes but taxes at the state and local levels, too. For example, if you are a freelancer living and working in New York, assume you will be paying federal taxes, New York State taxes, and, if you live in New York City, city taxes as well. On the plus side, you don’t have to pay Social Security or Medicare taxes on unemployment income as you would for regular freelance income.

There are a few states that exempt unemployment benefits from taxes, so check your federal, state, and local tax liabilities. 
California, Montana, New Jersey, Oregon, Pennsylvania, and Virginia are among the states that waive income taxes on unemployment income. Additionally, some states don’t levy income taxes at all, including on unemployment benefits received by residents there. Those states are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.

Even if your state is waiving taxes on unemployment income, you will still owe federal taxes on it, and potentially local taxes, too.
Given the impact unemployment income may have on your freelance tax picture, now is the time to look at how any unemployment payments you received will impact your freelance tax obligations, both for this quarter and for 2020 overall, so you can make necessary adjustments to your plans for tax payments.

Managing your freelance tax obligations proactively is key during the pandemic and beyond. 
This year more than ever, it is critical for freelancers to keep abreast of the tax impacts created by the pandemic to avoid any tax season surprises. If you haven’t engaged in tax planning for your freelance business yet this year, start with your preparations for the next estimated tax payment, taking the time to look at your federal, state, and local tax obligations in light of participation in the PUA.

—Jonathan Medows is a New York City-based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country.

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