Some Taxpayers—Not All—May Want to Amend Unemployment Taxes

The IRS officially announced that they plan to automatically issue refunds to anyone who filed their taxes before the American Rescue Plan (ARPA) made $10,200 of unemployment income tax-free. They also intend to adjust credits or deductions to the extent possible, so you may get even more of a boost. Win-win, right?

Well, this is good news for some and not-as-good news for others—either way, it’s confusing. Here’s what they plan to adjust vs. what they don’t, and whether you should amend your tax return or let the IRS automatically distribute your refund.

What will the IRS automatically calculate and apply?

The IRS intends to return any unemployment taxes you paid, plus adjust any credits or deductions you initially claimed on your taxes based your new adjusted gross income (AGI) figure. Removing up to $10,200 of unemployment income from your tax return will lower your AGI, and AGI is used as a qualifier for a number of tax breaks.

For example, taxpayers who claimed the Earned Income Tax Credit (EIC) may now be eligible for an increase in the EITC amount, which may result in a larger refund or a smaller bill for taxes owed.

The best part if you are in this camp? You won’t have to lift a finger—the IRS plans to determine the amount you qualify for and send it accordingly throughout spring and summer. That amount will either be sent as a refund or applied to any outstanding taxes owed.

What would I need to file an amended return for?

There’s one big detail that you should definitely pay attention to here: The IRS can adjust the amount of a previously-claimed tax break, but not the new eligibility of one. Your adjusted unemployment benefits may now qualify you for a credit or deduction that you wouldn’t have been eligible for before, but the IRS isn’t able to perform those calculations. In that case, you might get more money back in your pocket by filing an amended return.

What should you do? We recommend everyone look at your taxes again post-ARPA. Log in to 1040.com if you filed with us this year and look at the new result on your return to see how your tax situation is affected; if it turns out you now qualify for some new credits or deductions, file an amended return to ensure that you get the maximum benefit from the new law change (you can print everything you need on 1040.com!).

If, on the other hand, your only benefit is a reduction in tax based on the unemployment exclusion and you aren’t newly qualified for any other tax breaks, your best bet is to sit back and let the IRS do the heavy lifting.

For automatic distributions, what’s the plan?

Payments will come in two phases: First, the IRS will handle taxpayers eligible for the $10,200 range (up to that amount), and second, the taxpayers eligible for the amount capped at $20,400. The $20,400 range is for married taxpayers and those with more complex returns, and the $10,200 range is for all other eligible taxpayers.

Will my state automatically adjust my state return, too?

Not likely, which is important to remember. Your state may handle unemployment benefits differently, so be sure to check if unemployment benefits are tax-free on the state level. Some states never tax unemployment benefits, while others always do (even if the federal rules make an exception, as with ARPA). If your state conformed to the federal exclusion, refigure your state taxes to see what you could get back by filing a state amended return.