What Unemployment Does to Your Taxes

NEW YORK (MainStreet) -- The unemployment situation in the U.S. remains bleak at best and utterly hopeless at worst for the millions who have yet to find work.

As the Bureau of Labor Statistics recently reported, “Nonfarm payroll employment was essentially unchanged in June (+18,000), and the unemployment rate was little changed at 9.2% … Employment in most major private-sector industries changed little over the month. Government employment continued to trend down.”

The bureau also reported that “the number of unemployed persons (14.1 million) and the unemployment rate (9.2%) were essentially unchanged during the month. Since March, the number of unemployed people has increased by 545,000, and the unemployment rate has risen by 0.4 percentage points. The labor force, at 153.4 million, changed little over the month.”

With news like that, it pays to know what unemployment might mean for your taxes if you’re in a similar predicament. If you count yourself among America’s unemployed, make sure you know the basics of these income tax consequences that might affect your finances:

Unemployment Benefits

The unemployment benefits you get are fully taxable on your federal income tax return. The first $2,400 of benefits was excluded from federal income tax for 2009 only, as this was a one-time exclusion that wasn’t extended for last year or this year. Benefits may also be taxed on your state income tax return, so be sure to check your state; for example, New Jersey does not tax unemployment benefits and New York does.

You can elect to have federal income tax, and perhaps state income tax, withheld from your unemployment benefits. In most cases the federal withholding is limited to 10%. When you apply for unemployment, whether online or in person, you should be asked if you want income tax withheld. This may be a good idea if you’re married and your spouse is employed full time.

Tax Credits

The lower income resulting from being out of work may make you eligible for the federal, and possibly state, Earned Income Credit, which is based on your Adjusted Gross Income. To qualify for the EIC you must have some W-2 income or net earnings from self-employment this year.

You do not need to have a dependent child or be married to claim the credit, but a net loss from a self-employment activity can wipe out W-2 income and make you ineligible. And excessive unemployment can also wipe out this benefit.

As with just about all of the tax breaks related to or resulting from unemployment, this will be of no service to you. You’ll have to wait until you file your 2011 tax return next year to get the benefits.

If you have dependent children under age 17, your lower income may allow you to claim a refundable Child Tax Credit.

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