State Tax Treatment of Unemployment Benefits

Because of COVID-19, the state tax treatment of unemployment benefits will be a bigger deal than usual when individuals file their state returns for tax year 2020. In part, this is because of the unusually high number of people who have lost work during 2020 and who therefore may have received unemployment benefits during the year.

In addition, unemployment benefits have been expanded in 2020. For example, the CARES Act not only authorized additional workers to receive unemployment benefits, but it allowed an extra $600 per week and an extra 13 weeks of benefits. Therefore, for many people receiving unemployment benefits in 2020, the amount received may be substantially larger than would normally be the case.

Federal Tax Treatment of Unemployment Benefits

At the federal level, unemployment compensation is included in income. This is because unemployment compensation is designed to compensate individuals for the loss of income caused by involuntary layoffs. Accordingly, the benefits are treated as replacing the individual’s wages or other compensation and are taxable in the same way.

State Tax Treatment of Unemployment Benefits

Most states follow the federal treatment and require any unemployment compensation received to be included in income and subject to tax.

However, a number of states do not impose tax on unemployment benefits. For example, California allows taxpayers to take a subtraction from federal taxable income for the full amount of unemployment compensation received and taxed at the federal level.

Among the other states allowing a full personal income tax exclusion for unemployment benefits are:

  • Montana;
  • New Jersey;
  • Pennsylvania; and
  • Virginia.

Other states, such as Wisconsin, may allow a portion of the unemployment benefits to be excluded from taxation. Taxpayers completing the Wisconsin individual income tax return use a special worksheet to calculate the subtraction amount.

State Tax Developments and Guidance for 2020

In 2020, no state has changed its income tax treatment of unemployment benefits.

However, a number of states have issued reminders and other guidance to taxpayers to clarify the treatment of those benefits, including the expanded unemployment benefits available because of COVID-19.

California released a set of FAQs confirming that the emergency increase of $600 per week in unemployment benefits under the CARES Act is not subject to California income tax.

On the other hand, Hawaii announced that payments of additional unemployment compensation under the CARES Act are subject to Hawaii income tax. Similar announcements were made by Massachusetts, Minnesota, and South Carolina.

Oregon also announced that the unemployment benefits are taxable and further noted that unemployment benefit recipients should receive a Form 1099-G in January 2021 showing the amount, which will then need to be reported, along with Form W-2 income, on the 2020 federal and state income tax returns.

Wisconsin’s FAQ on unemployment compensation notes that the additional $600 per week under the CARES Act may be subject to tax. Taxpayers must use the state’s worksheet to calculate the subtraction amount allowed.

By Brian Plunkett, J.D.

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