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America's jobless owe thousands of dollars in taxes on their unemployment

Erika Rose was shocked this month when she sat down to do her taxes and realized she owed $600 to the federal government. She's been unemployment since April and has spent much of the winter stretching every penny to pay rent and to keep the lights on. On a recent trip to the grocery store, she only had $20 in her bank account. 

"I was so upset. How do I owe over $600 in taxes?" said Rose, 31, who lives in Los Angeles. "I have never been so fearful in my life of how I'm going to pay my bills."

Rose is among millions of unemployed workers facing surprise tax bills, ranging from several hundred to several thousand dollars, and many say they just can't pay. For tax purposes, weekly unemployment payments count as income just like wages from a job. But few people realize the money they get from the government is actually taxable. Fewer than 40% of the 40 million unemployed workers in 2020 had taxes withheld from their payments, according to The Century Foundation, a left-leaning think tank.

For people who have been without a job for nearly a year, finding money to pay their tax bills is yet another financial burden coming at a fraught time. Advocates for the poor as well as some Democratic lawmakers are trying to get these tax bills waived entirely - or at least reduced.

"I don't think we should be taxing unemployment insurance benefits, generally, but we really should not be taxing them during a terrible recession," said Brian Galle, a professor at Georgetown Law. "The right thing to do is just zero out unemployment insurance income from last year."

Among the unemployed, there was hope that Congress would eliminate taxes on unemployment income, but that provision did not make it into the latest $1.9 trillion bill Democrats are aiming to have on President Joe Biden's desk by mid-March.

Unemployment insurance was created in 1935 during the Great Depression era as a safety net to help people out of work. For decades,it was not taxed, but in the late 1970s and early 1980s there was a push to make all forms of income taxable. All unemployment payments were subject to federal income tax by 1986. The thinking was that if a rich person lost their job and collected unemployment, they should still be taxed. Others argued that not taxing unemployment aid might discourage people from looking for work where their wages would be taxed.

"The basic theory is everyone should pay tax on it as income. Just because they are unemployed doesn't change that," said Pete Davis, who worked on tax reform in the 1970s and 80s in Congress.

Outside of a recession, Americans usuallyremain on unemployment for a few months, so the tax bills are modest. But during recessions, or large-scale natural disasters, it's more common for people to be unemployed for a year or more, causing a much heftier tax bill. That's why Congress has typically eliminated at least some of the tax bill for the unemployed during past downturns as a way to lessen the financial pain.

States handle taxation of unemployment benefits in very different ways. Nine states don't have income taxes, so they don't tax unemployment benefits. Another six states - Alabama, California, Montana, New Jersey, Pennsylvania, and Virginia - opted not to tax unemployment at the state level. And during the pandemic, Maryland and Delaware decided to temporarily not tax unemployment, according to Lucy Dadayan, a senior research associate at the Tax Policy Center.

Some argue that the unemployed should have done a better job saving up for their tax bill. When people fill out the application for unemployment aid, there is a box they can check to have taxes withheld, similar to what most people do with paychecks at a job.

But several jobless Americans told The Washington Post that they ended up with hefty tax bills even though they did check the box. Rose is one of them. When she lost her job in April at a company that processes debit and credit card transactions, she made sure to check the box to have taxes withheld. But she still ended up owing the federal government taxes.

It was the same for Taryn Johnston. Since being laid off from her medical aesthetician job at a plastic surgery practice when the pandemic escalated, she had the maximum withheld every week from her unemployment checks for taxes. Despite trying to do the right thing, she still ended up with owing $1,500 when she sat down recently to fill out her federal and state tax forms for 2020.

"This whole situation is crazy," said Johnston, 41, who lives in Brooklyn. "My savings is gone. Most of my 401k is gone. I'm $6,000 in credit card debt and behind on my rent and now I owe the government $1,500 in taxes on my unemployment."

Johnston says she's trying to save up money to pay the tax bill by the April 15 deadline. The plastic surgery practice where she works has started giving her more hours, but she's living on half the money she made pre-pandemic. Her best hope is for Congress to pass the $1,400 stimulus checks - money that she would receive and then turn right around and send to the Internal Revenue Service.

"When I get this stimulus check that's coming, it's going to end up going to my taxes," Johnston said.

Among other ideas in Congress,Sen. Dick Durbin, D-Ill., and Rep. Cindy Axne, D-Iowa, have introduced separate legislation that would eliminate taxes on the first $10,200 of unemployment benefits received in 2020. This proposal is similar to what Congress did during the Great Recession when a portion of unemployment income was not taxed. Sofar, the bill has not advanced.

Opponents of the Durbin bill argue that it is a costly provision - estimates are around $30 billion - and the money is better spent elsewhere. They say it would be wiser to extend unemployment insurance benefits longer to continue helping those deeply in need. Lowering taxes now on 2020 unemployment aid would help a lot of people who have already returned to work, critics say.

"The important policy question is: Who is falling through the cracks?" said Jared Walczak, a vice president at the right-leaning Tax Foundation. "The priority should be making sure there's uninterrupted benefits for those in need."

Time is running out for Congress to make tax changes to help with the tax filling season underway since Feb. 12.

Another option discussed in economic policy circles and advocated by the law professor Galle and Elizabeth Pancotti of Employ America, would be for Biden's Treasury Department to simply waive taxes on most of the unemployment payments in 2020. Galle and Pancotti argue Treasury has done this before during natural disasters, and the pandemic is a large-scale disaster. However, two senior Treasury officials who were not authorized to speak publicly said that idea is not on the table.

Elaine Maag, a researcher at the Tax Policy Center, says a more practical solution at this point is probably for the IRS to grant people who were on unemployment last year more time to pay their taxes.

"I'm very sympathetic to someone showing up having a large tax bill they weren't expecting," said Maag. "I think they should get a generous payment plan and not have anything due for many months or until they are back at work."

Longer term, Maag said the ideal solution would be for the unemployed to fill out W-4 withholding tax forms, the same as most workers hand into their employers when they start a new job. Most states withhold a flat 10 percent for federal taxes on unemployment compensation, which doesn't take into account the complexity of many people's tax situations. This is the reason so many owe more now, even if they did check the box for withholding.

Proponents of forgiving taxes on unemployment point out that the pandemic recession was the most unequal in modern U.S. history, decimating low-wage workers. These Americans are the least likely to have any savings or be able to handle a surprise bill. Nearly half of adults receiving unemployment between March and November lived in households with incomes below $50,000, according to a Century Foundation analysis of U.S. Census data.

They also point out that the pandemic was an especially chaotic situation, with such a flood of people applying for unemployment last spring that many state offices were overwhelmed and unable to give people guidance on withholding.

Take what happened to Kate Shine in Brooklyn. The state of New York told her there was a problem with her unemployment record in the state's computer system so the only way she could get unemployment was to call each week to file her claim. Shine, 34, did that, but she says there wasn't an option on the phone system to withhold taxes.

Now Shine owes several thousand dollars in taxes, a huge bill she's struggling to figure out how to pay, as she has still not been able to find another copywriter job.

"Lots of us feel surprised we owe thousands of dollars," Shine said. "It just sucks. And it feels so unfair giving everything that's been happening in this pandemic."

- - -

The Washington Post's Jeff Stein contributed to this story.

 

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