Unemployed workers who lost their federal benefits this year are now faced with another hit to the pocketbook: their tax bills.
All federal jobless benefits are taxed just like wages, and 33 states plus the District of Columbia fully tax their unemployment insurance as well, according to the Tax Foundation. As many of the long-term unemployed still haven't found jobs, that could mean shelling out thousands of dollars—or owing it, with interest, to the government.
It can be an unwelcome surprise for jobless workers who didn't realize their benefits were taxed and have burned through them already. "There are a fair amount of people that assume either the benefits are not taxable or that withholding is happening on them autohaomtically—that’s how it worked when they got their paychecks," says Lindsey Buchholz, a tax attorney at H&R Block's Tax Institute.
Mary Mitchell, 46, estimates that she'll owe some $3,000 in taxes on the unemployment benefits she received in 2013. A former payroll manager now living in Cincinnati, Mitchell simply hopes that a delayed tax refund will help cover most of her tax burden because she's burned through her savings and 401(k) already. "I've barely got gas to get to class," says Mitchell, who's been out of work since 2012.
Washington didn't always tax jobless benefits. Federal taxes on unemployment began in 1979, and they only applied to those with adjusted gross incomes above $20,000 for single people and $25,000 for couples. Three years later, Congress lowered the thresholds further—not only to raise revenue, but also because legislators believed the tax break was a disincentive to work.
Then, in 1986, as part of comprehensive tax reform, all federal unemployment benefits became fully taxable and treated like wage income. The argument then, as now, was that unemployment checks were meant to be a substitute for wages and salaries and thus should be taxed as such.
"The net benefit is greater if you don’t tax it than if you do—so government is effectively giving you more money if you don’t tax it," says Roberton Williams, a fellow at the Tax Policy Center.
Since the 1980s, there has been sporadic interest in rolling back the federal taxes on unemployment benefits, particularly during times of economic distress. In 2003, for instance, then-Rep. Phillip English, a Pennsylvania Republican, proposed legislation repealing the tax on unemployment benefits altogether, but the bill went nowhere.
More recently, the 2009 stimulus exempted the first $2,400 in federal unemployment benefits from taxation. But the tax break lasted only one year, even though long-term unemployment has remained at historic highs.
But some jobless workers and their advocates think unemplyment insurance (UI) benefits should still be exempt from taxation. "I don't believe UI benefits should be taxed at all—workers' comp isn't, and UI never used to be," says Judy Conti, federal advocacy coordinator for the National Employment Law Project. "People are only collecting a fraction of what they earned, and in these kind of circumstances, they should get a tax break as well."
Mitchell agrees. "Everything has been thrown back on the taxpayers and the popel, the cities, the localities, and the states," she says. "They have gone up on fees and tax increases, at the same time pay hasn’t changed."
It's still up to the states to decide whether to tax their own unemployment benefits, which typically last up to 26 weeks. Six states—Maryland, California, Virginia, New Jersey, Oregon, and Pennsylvania—exempt state unemployment aid from taxes, according to the Tax Foundation. Indiana and Wisconsin partially exempt some benefits from taxation.
But on the federal level, legislators have focused on whether to extend federal benefits for the long-term unemployed, and tax breaks haven't been part of the larger conversation. House Republicans are refusing to take up the extension, arguing that the White House needs to amend the legislation to make sure it creates jobs first.
There are other ways for the unemployed to help soften the blow of their tax bills. Like other financially strapped Americans, they can apply for a short-term, 120-day extension or try to set up a payment agreement with the IRS to pay their taxes in installments. But some make the mistake of thinking they can defer their payments simply by getting an extension to file their taxes.
"I don’t think it’s something most people look into until they go into that situation; a lot of people are pretty unaware of what the options are," says Buchholz. "Taxes are due even if you file an extension, and you could end up with penalties and interest." So that could be yet another cost of long-term unemployment.