Your business’s employees who were unemployed for part of 2020 will be pleased to know that a portion of that income might not be taxable at the federal level — and possibly at the state level, as well. The American Rescue Plan, enacted on March 11, 2021, allows individuals with modified adjusted gross income (AGI) less than $150,000 to exclude from income up to $10,200 of unemployment compensation paid in 2020.

For married couples, each spouse receiving unemployment compensation can exclude up to $10,200. Amounts over $10,200 for each individual are still taxable. Note that nonresident aliens can’t exclude any unemployment compensation for their spouses.

Taxpayers with income tax filing requirements in one or more state will need to follow each state’s guidance regarding conformity with the federal law.

The IRS has indicated that taxpayers who have already filed 2020 Form 1040 or 1040-SR should not file an amended return. The IRS will refigure the individual’s taxes using the excluded unemployment compensation amount and will send any refund amount directly to the taxpayer.

The IRS has updated its instructions for reporting unemployment compensation on Schedule 1 of Form 1040. The following are a few highlights that you might consider sharing with employees:

  • When figuring deductions or exclusions from income — such as those for taxable Social Security benefits, IRAs, student loan interest, tuition and fees, or passive rental real estate activity — if the taxpayer is asked to enter an amount from Schedule 1, line 7, they should enter the total amount of unemployment compensation reported on line 7 (unreduced by any exclusion amount). If they are asked to enter an amount from Schedule 1, line 8, they should enter the amount from line 3 of the Unemployment Compensation Exclusion Worksheet. (Taxpayers should review the specific form or instructions for more information.)
  • Taxpayers who received unemployment compensation in 2020 should receive one or more Forms 1099-G. Review these forms carefully. If the amount reported in box 1 of the form is incorrect, report on line 7 only the actual amount of unemployment compensation paid to you in 2020.
  • Note that a state may issue separate Forms 1099-G for unemployment compensation received from the state and the additional $600-per-week federal unemployment compensation related to coronavirus relief. Include all unemployment compensation received on line 7.
  • Some states may issue an electronic Form 1099-G. Check the state’s unemployment compensation website for more information.

We are here to help you navigate the ongoing effects of the COVID-19 pandemic. Please check CRICPA.com often for the latest updates on individual and business taxation, and contact your CRI advisor with specific questions about how these changes affect your business.