Taxation of Unemployment Benefits
Julie M. Whittaker
Specialist in Income Security
September 13, 2012
The House Ways and Means Committee is making available this version of this Congressional Research Service
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Taxation of Unemployment Benefits
Summary
Unemployment compensation (UC) benefits have been fully subject to the federal income tax
since the passage of the Tax Reform Act of 1986 (P.L. 99-514). Individuals who receive UC
benefits during a year may elect to have the federal (and in some cases state) income tax withheld
from their benefits. The American Recovery and Reinvestment Act of 2009 (P.L. 111-5 §1007)
included a temporary exclusion on the first $2,400 of UC benefits for the purposes of the federal
income tax. This exclusion existed only in 2009. The Joint Committee on Taxation estimated this
would reduce federal receipts by approximately $4.7 billion.
There is no federal income tax exclusion for unemployment benefits for tax years 2010 or 2011.
The Workforce Fairness and Tax Relief Act of 2011 (H.R. 2806) would repeal the taxation of
unemployment benefits and any trade adjustment assistance payments.
This report provides an overview of the taxation of UC benefits and legislation related to taxing
UC benefits. This report will be updated as legislative activity warrants.
Congressional Research Service
Taxation of Unemployment Benefits
Contents
Overview.......................................................................................................................................... 1
Impact of Taxing Unemployment Benefits...................................................................................... 1
Legislative History........................................................................................................................... 3
Legislation in the 112th Congress..................................................................................................... 4
Legislation in the 111th Congress..................................................................................................... 4
Tables
Table 1. Number of Federal Tax Returns With Reported Unemployment Compensation
(UC) and Amount of Benefits, Tax Years 1998-2009................................................................... 2
Table 2. Estimated Effect of Taxing Unemployment Compensation, by Income Class,
2005 .............................................................................................................................................. 3
Contacts
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Taxation of Unemployment Benefits
Overview
Unemployment benefits are subject to the federal income tax. This tax treatment, which has been
in place since 1987, puts all Unemployment Compensation (UC, as defined by tax law)1 on an
equal basis with wages and other ordinary income with regard to income taxation. Unemployment
benefits are not subject to employment taxes, including Social Security and Medicare taxes,
because the benefits are not considered to be wages.2 For tax year 2009 only, the first $2,400 of
unemployment benefits was excluded from the federal income tax. In all subsequent tax years no
UC benefits were excluded.
In addition to being subject to federal income taxes, in most states that have an income tax,
unemployment benefits are taxed.3 Most other industrial nations also tax unemployment benefits.
State UC agencies must give UC beneficiaries the opportunity to elect federal income tax
withholding at the time the claimant first files for UC benefits. Benefits claimants wishing to have
federal income tax withheld from their UC benefits must file form W-4V, Voluntary Withholding
Request. The current withholding rate for federal income tax is 10% of the gross UC benefits
payment. Federal law does not require that states offer state income tax withholding to UC
beneficiaries, although many do offer such services. Beneficiaries may opt to pay quarterly
estimated taxes if a state does not offer state income tax withholding.
Impact of Taxing Unemployment Benefits
Table 1 shows the number of federal income tax returns that reported unemployment benefits and
the amount of unemployment benefits for tax years 1998 through 2009. The increases in the
number of tax returns claiming unemployment benefits as income filed in 2001 through 2003 are
attributable to the 2001 economic recession and the policy responses, including the temporary
extension of unemployment benefits (the Temporary Emergency Unemployment Compensation
program) and providing additional benefits for individuals affected by the 2001 terrorist attack.
The most recent recession that began in December 2007 is reflected in the sharp increases in 2008
and 2009 tax returns with an estimated additional 3.7 million tax returns claiming unemployment
benefits as income in 2009 as compared with tax filings for 2007.
1 Under tax law, unemployment compensation is a broad category that includes regular state UC benefits, extended
benefits (EB), trade adjustment assistance benefits, disaster unemployment assistance, and railroad unemployment
benefits.
2 The federal and state unemployment taxes (FUTA and SUTA) on employers also do not apply to these benefits.
3 Although most states tax UC benefits, some states exempt the benefits from state income taxes. A few states impose a
lowered tax rate on unemployment benefits. Information on a particular state tax treatment of unemployment benefits
should be available at the appropriate state tax authority.
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Taxation of Unemployment Benefits
Table 1. Number of Federal Tax Returns With Reported Unemployment
Compensation (UC) and Amount of Benefits,
Tax Years 1998-2009
Number of
Returns
Amount
Year
(millions)
(millions of $)
1998 7.1 16,777
1999 6.8 17,649
2000 6.5 16,982
2001 8.8 26,891
2002 10.3 43,130
2003 10.1 44,008
2004 9.1 32,740
2005 7.9 27,857
2006 7.4 26,524
2007 7.6 29,415
2008 9.5 43,675
2009 11.3 83,538
Source: Table prepared by the Congressional Research Service (CRS) from data contained in the Internal
Revenue Service, Statistics of Income Bulletins, various years.
Note: Tax year 2009 does not include the first $2400 of unemployment benefit income and thus both the
number of tax filers and the amount of benefits are understated as compared with years when al unemployment
benefits were taxable.
Under tax law, “Unemployment Compensation” is broad category that includes regular state UC benefits,
extended benefits (EB), trade adjustment assistance benefits, disaster unemployment assistance, and railroad
unemployment benefits.
Typically, the loss of a job, even with unemployment benefits, results in a decline in earned
income and often in total income. Unemployment benefits are not considered earned income for
purposes of computing the earned income tax credit, and the earned income tax credit is not
available if adjusted gross income4 (AGI) exceeds a certain level or if investment income
(interest, dividends, and capital gains distributions) exceeds a certain level.5
Table 2 shows Congressional Budget Office (CBO) estimates of the effect of taxing
unemployment compensation at various income levels. Families that reported an income of less
4 The IRS defines AGI as taxable income from all sources including wages, salaries, tips, taxable interest, ordinary
dividends, taxable refunds, credits, or offsets of state and local income taxes, alimony received, business income or
loss, capital gains or losses, other gains or losses, taxable IRA distributions, taxable pensions and annuities, rental real
estate, royalties, farm income or losses, unemployment compensation, taxable social security benefits, and other
income minus specific deductions including educator expenses, the IRA deduction, student loan interest deduction,
tuition and fees deduction, Archer MSA deduction, moving expenses, one-half of self-employment tax, self-employed
health insurance deduction, self-employed SEP, SIMPLE, and qualified plans, penalty on early withdrawal of savings,
and alimony paid by the tax payer.
5 For example, for tax year 2005, an adjusted gross income of more than $11,750 would disqualify a single taxpayer
with no children, an adjusted gross income of more than $37,263 would disqualify a married couple with two children.
Investment income of more than $2,700 would disqualify any taxpayer.
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Taxation of Unemployment Benefits
than $10,000 in 2005 received an estimated $1.8 billion in UC benefits but only paid $6 million
in taxes on those benefits. In comparison, families reporting an income between $50,000 and
$100,000 received an estimated $7.3 billion in unemployment benefits and paid $1.2 billion in
taxes on those benefits.
Table 2. Estimated Effect of Taxing Unemployment Compensation,
by Income Class, 2005
UC Benefits
Affected by
Percentage
Taxes
Level of Individual Recipients
Taxation of
Affected
Total Taxes
as a %
or Couple
of UC
Benefits
by
Total UC
on Benefits
of Total
Incomea
(thousands) (thousands of $)
Taxation
(millions of $)
(millions of $) Benefits
Less than $10,000
755
82
11
1,829
6
0.3
$10,000 to $15,000
865
344
40
2,608
75
2.9
$15,000 to $20,000
818
382
47
2,799
136
4.9
$20,000 to $25,000
758
408
54
2,643
165
6.3
$25,000 to $30,000
676
388
57
2,391
176
7.4
$30,000 to $40,000
955
664
70
3,540
319
9.0
$40,000 to $50,000
758
634
84
2,825
371
13.1
$50,000 to $100,000
1,944
1,854
95
7,322
1,216
16.6
At least $100,000
536
531
99
2,464
671
27.2
All 8,064
5,288
66
28,423
3,135
11.0
Source: Congressional Budget Office (CBO).
a. Income is defined as AGI plus statutory adjustments, tax-exempt interest, and nontaxable social security
benefits.
Legislative History
Before 1979, UC benefits were not subject to the federal income tax. In the Revenue Act of 1978
(P.L. 95-600), UC benefits were made partially taxable for benefits received after December 31,
1978. Benefits were taxable only for tax filers whose AGI exceeded $20,000 (single filers) or
$25,000 (joint filers).6 Taxation was applied to the lesser of (1) UC benefits or (2) one-half of
AGI (with UC benefits included) in excess of the above-mentioned AGI thresholds.7
During the 1970s, some policy studies had shown that the proportion of wages replaced by UC
benefits on an after-tax basis was large enough to erode a claimant’s work incentive.8 Taxation of
UC benefits served to reduce the degree of after-tax wage replacement and reduce the work
disincentive effect. However, UC benefits of lower income claimants remained untaxed because
6 If the thresholds were adjusted for inflation, the comparable 2007 values would be $57,120 and $71,400.
7 Joint Committee on Taxation, General Explanation of the Revenue Act of 1978 (H.R. 13511, 95th Congress, P.L. 95-
600), March 12, 1979, p. 23.
8 For example, see Martin Feldstein, “Unemployment Compensation: Adverse Incentives and Distributional
Anomalies,” National Tax Journal, June 1974.
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Taxation of Unemployment Benefits
their total income was under the tax threshold (i.e., their standard deduction and personal
exemptions offset their income).
In 1982, Congress lowered the AGI thresholds for taxation of UC benefits. The Tax Equity and
Fiscal Responsibility Act of 1982 (P.L. 97-248) reduced those thresholds to $12,000 for single
filers and $18,000 for joint filers.9 A primary motivation of this legislation was to raise revenue,
but it left in place a policy of protecting lower-income claimants from taxation of UC benefits.10
Congress made UC benefits fully taxable in the Tax Reform Act of 1986 (P.L. 99-514), effective
for benefits received after December 31, 1986. Although this action reversed the original policy
of taxing UC benefits only above an AGI threshold, it occurred in the context of a law that
removed many low-income filers from the tax rolls, lowered the marginal tax rates for the
majority of taxpayers, and expanded eligibility for the earned income credit. The rationale for full
taxation of UC benefits was to treat UC benefits the same as wages and to eliminate the work
disincentive caused by favorable tax treatment for UC benefits relative to wages.11
Concern about claimants’ cash flow problems caused by the lack of tax withholding from UC
benefits arose during the 1990-1991 recession. P.L. 102-318 required states to inform all new
claimants of their responsibility to pay income tax on UC benefits and to provide them with
information on how to file estimated quarterly tax payments. In 1994, P.L. 103-465 required
states to withhold federal income tax from UC benefits if a claimant requested withholding, and
permitted states to withhold state and local income taxes. P.L. 103-465 set the federal withholding
rate at 15% of the gross benefit payment amount. The federal withholding rate was changed to
10% by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-
16) effective August 7, 2001.
Legislation in the 112th Congress
On August 5, 2011, Representative Michaud introduced the Workforce Fairness and Tax Relief
Act of 2011, (H.R. 2806). The bill would repeal the taxation of unemployment benefits and any
trade adjustment assistance payments. It would also eliminate the penalty for distributions from a
qualified retirement plan to an individual after separation from employment if the individual had
received at least 24 weeks of UC. The bill would apply to benefits received after December 31,
2010.
Legislation in the 111th Congress
The American Recovery and Reinvestment Act of 2009 (P.L. 111-5 §1007) included a temporary
exclusion on the first $2,400 of UC benefits for the purposes of the federal income tax. This
9 If the thresholds were adjusted for inflation using the All Items Consumer Price Index for All Urban Consumers (CPI-
U), the comparable 2011 values would be $28,132 and $42,198.
10 Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Tax Equity and Fiscal
Responsibility Act of 1982 (H.R. 4961, 97th Congress; P.L. 97-248), December 31, 1982, pp. 28-29.
11 Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (H.R. 3838, 99th Congress; P.L.
99-514), JCS-10-87, May 4, 1987, pp. 29-30.
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Taxation of Unemployment Benefits
exclusion applied only for the 2009 tax year. The Joint Committee on Taxation estimated that this
exclusion would reduce federal receipts by approximately $4.7 billion.
Among many provisions, S. 2831 would have suspended the federal taxation of the first $2,400 of
unemployment benefits through 2010. H.R. 4718 would have suspended the federal taxation of all
unemployment benefits through 2012.
Acknowledgments
This report was originally written by Christine M. Scott. All inquiries should be directed to the current
author listed.
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