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Not everyone received unemployment benefits in 2020, but for those who did … it was a glorious mess.  This gets confusing so please hang on.  But remember, as of this writing, the exemption from taxation of some unemployment benefits is for 2020 only!

Until early March 2021, tax returns prepared in our office included as income all unemployment payments (this is the normal rule). 

In March, Congress retroactively changed the rules.  For 2020, they declared that the first $10,200 of unemployment income would be exempt from taxation effective January 1st, 2020. (There are some income restrictions.  Also, for a married couple, each spouse could exempt $10,200,). This meant that if you filed your 2020 tax return before the law was enacted or changes were made to our tax software, you overpaid your taxes!

Understanding the changed law’s broad impact, the IRS asked/instructed taxpayers who were impacted not to file an amended return.  Rather, the IRS computer would automatically adjust the return and send you the increased refund (or lower your amount owed).

There is a problem with the IRS’s “fix”.  The IRS computer will likely accurately make simple adjustments.  However, we highly doubt the computer will pick up more complicated items.  Does your lower income make you eligible for credits that you did not qualify for originally?  There is only one way to determine if the IRS adjustment is correct – and that is to run it through our software.

Community Property Rules Mess – But a Beneficial Mess

At the end of May, the IRS threw us another curve ball.  If you are married, live in a community property state like Texas and do not have a pre/postnuptial agreement, the IRS properly dictated that the unemployment payments are community property income.  This means that any payment to one spouse is really a payment of one half the payment to each spouse!  This is a big deal!  Consider this example:

Mr. Smith receives $25,000 in unemployment benefits in 2020.  Mrs. Smith received no unemployment payments.  If they were aware of the exemption when they filed their return, they would have exempted $10,200 of Mr. Smith’s benefits from taxation leaving $14,800 subject to tax.  However, after the IRS ruling acknowledging that under community property rules, the $25,000 should be reflected as a $12,500 payment to Mr. Smith and a $12,500 payment to Mrs. Smith, he can amend their return to exempt $10,200 from his benefits and $10,200 from his benefits that were allocated to her by the community property rules.  The Smith’s amended return would now reflect $20,400 exempt from tax leaving only $4600 subject to tax!

 

Note:  This is not something the IRS computer will automatically fix.  We will need to file an amended return.

How to Proceed?

We think it easiest to break your situation down as follows:

  1. If you received unemployment benefits in 2020 AND you filed your return through our office before approximately March 1 (we ceased sending returns with unemployment income at that time as we waited for the law to be signed), please keep your eyes open for an IRS letter informing you that they have adjusted your account for unemployment proceeds. When that arrives:

  2. Provide us a copy of that notice.
  3. We will determine whether the IRS adjustment is correct; or,
  4. We will need to amend the return to fetch the rest of the money you have coming.
  5. If you received unemployment benefits in 2020 AND you filed your return in our office after March 1st, your return was likely prepared with the $10,200 exemption(s). However, if we filed your return before June 15th, we likely did not yet know about the IRS community property split tax ruling.  The IRS has said that they will also make this adjustment, but Marc is suspicious that the IRS computer is sophisticated to make that change.  There are simply too many variables.  But for now, we will wait for the IRS to make the change.  As such, you too will keep your eyes open for an IRS letter announcing an unemployment adjustment.  When that arrives:

 

  1. Provide us a copy of that notice.
  2. We will determine whether the IRS adjustment is correct; or,
  3. We will need to amend the return to fetch the rest of the money you have coming.

Considering it is taking the IRS a full year to process amended returns, waiting for the IRS computer to make adjustments is probably your best play for right now.

Contact Us

We would love the opportunity to let you know more about our firm and the solutions we could offer to meet your specific needs.

M-F: 8:30am to 5:00pm

5045 Lorimar Drive, Suite 280, Plano, TX 75093