Should I Really Have Federal Tax Withheld From Unemployment? + FAQs

Yes – in most cases you should opt to have federal income tax withheld from your unemployment benefits.

Electing to withhold a portion for taxes helps you avoid a surprise tax bill (or even penalties) when you file your return.

Over 40 million Americans filed for unemployment during the recent pandemic, and many were shocked at tax time because they hadn’t set aside any money for Uncle Sam.

Unemployment benefits feel like free money when you’re out of work, but the IRS treats them just like a paycheck for tax purposes.

Below, we’ll explore exactly why withholding makes sense, when it might not, and how different states handle taxing unemployment income.

• 🎯 A clear answer on whether to withhold taxes from your unemployment – and why it matters for your wallet

• 📝 Key terms and IRS rules (like Form W-4V and 1099-G) made simple so you know the paperwork

• 🗺️ How state tax laws differ, with a handy state-by-state guide to unemployment taxation across the U.S.

• ⚖️ The pros and cons of withholding vs paying later – complete with real examples of tax bills and refunds

• ⚠️ Common pitfalls to avoid so you won’t face penalties or a nasty surprise at tax time

The Straight Answer: Should You Have Taxes Withheld from Unemployment?

When it comes to unemployment benefits and taxes, the bottom line is that those benefits are taxable income. You aren’t required by law to have taxes withheld from your unemployment checks – it’s voluntary – but it’s usually a smart move.

Here’s why: Unemployment compensation is counted as gross income by the IRS (Internal Revenue Service), just like wages. If you receive, say, $500 per week in unemployment, that $500 is subject to federal income tax.

If you don’t pay any tax on it during the year, you could owe a chunk of money in April. By opting to have taxes withheld, you’re essentially pre-paying a portion of that tax so you won’t be caught off guard later.

Federal law allows (but doesn’t force) you to have a flat 10% of each unemployment payment withheld for taxes. This is similar to how employers withhold taxes from paychecks. For example, if you get $500 weekly, about $50 would be sent to the IRS and you’d receive $450.

That $50 goes toward your annual tax obligation. If you choose not to withhold, you get the full $500 now – helpful in the short term – but you’ll need discipline to set aside money for taxes on your own. Otherwise, you might spend it and struggle to pay the tax later.

Many people who opt out of withholding end up with a tax bill (sometimes in the thousands) when they file their return. Some even face an underpayment penalty if they underpaid their taxes by too much during the year.

So, should you have federal tax withheld? For most people, the answer is yes. Withholding 10% of your unemployment benefits is a simple way to avoid a big tax debt and possible penalties.

It effectively spreads your tax payments throughout the year, which the IRS prefers (the U.S. tax system is “pay-as-you-go”). If you return to work later in the year, having had taxes withheld from your benefits also means you’re less likely to be behind on taxes when combining your new wages. In short, withholding is usually the safe choice.

Are there times when you might not need or want to withhold? Yes, in a few cases. If your total income for the year is very low (for example, you only received unemployment for a short time and have little or no other income), you might end up owing little to no tax. In that scenario, withholding 10% might just lead to a refund at tax time.

Some people in dire need of every dollar of benefits might choose not to withhold and instead pay the tax later (or rely on a refund from other credits). That’s okay if you’re confident you can cover the tax bill with savings or other income when due.

Also, if you’re married and your spouse is working, you could adjust your spouse’s Form W-4 at their job to have more tax withheld from their pay instead of from your unemployment checks. This way, you still cover the tax, just from a different source. These are more advanced strategies though – for most unemployed workers, the straightforward approach is to let the unemployment office withhold the 10%.

In summary: Unemployment benefits do count as taxable income. To avoid headaches, most people should elect federal withholding on those benefits. It’s an easy step that can save you from a large bill or penalty later. Next, we’ll break down the key terms and rules you need to know to make this process as painless as possible.

Key Tax Terms Explained: IRS, Form W-4V, 1099-G, and More

When dealing with unemployment and taxes, you’ll encounter some important terms and forms. Let’s demystify the jargon:

• IRS (Internal Revenue Service) – The U.S. federal tax authority. The IRS is responsible for collecting federal income taxes, including tax on your unemployment benefits. When we say unemployment is “taxable,” it means you must report it to the IRS and pay any required federal tax on it. The IRS sets the rules (like the 10% withholding rate) and will also be the one to issue any tax refund or bill based on how much you paid in during the year. Essentially, think of the IRS as the scorekeeper making sure you pay the right amount of tax on your benefits.

• Unemployment Compensation – This is the formal term for unemployment benefits (sometimes called jobless benefits or UI benefits). It’s the money paid to you, usually by your state’s unemployment agency, when you lose your job through no fault of your own. These payments are funded by unemployment insurance taxes that employers (and in some states, employees) pay into a state fund. For tax purposes, unemployment compensation is treated as ordinary income. There is no special tax break for it in normal years (with one notable exception in 2020, which we’ll touch on later). So, whenever you see “unemployment compensation” on tax forms or guides, it refers to the benefits you received – and it’s taxable.

• Form W-4V (Voluntary Withholding Request) – This is the IRS form you use to request tax withholding from certain government payments, like unemployment benefits (and also Social Security benefits, if applicable). If you decide to have taxes withheld from your unemployment checks, you’ll likely fill out Form W-4V and submit it to your state unemployment agency (not to the IRS directly). On this form, you typically check a box to have 10% withheld from your unemployment payments. (For unemployment, 10% is the only rate allowed.) Once processed, the state will start deducting federal tax from your checks. You can stop or change this election by submitting a new W-4V if needed. In some states, when you first apply for benefits, they’ll ask you if you want withholding – essentially the same process without a paper form. But W-4V is the universal form if you need it. Remember, W-4V is voluntary – you only fill it out if you want the withholding; otherwise, the default is no tax taken out.

• Form 1099-G (Certain Government Payments) – This is a tax form you’ll receive if you got unemployment benefits during the year. Each state’s unemployment office will send out a Form 1099-G (usually in January) showing how much you received in benefits and how much was withheld for taxes, if anything. The “G” stands for government. Box 1 of this form shows “Unemployment Compensation” – the total benefits paid to you that year. Box 4 shows “Federal income tax withheld” – the total amount of federal tax they withheld (if you opted in). There may also be entries for state tax withheld, depending on your situation. Why is the 1099-G important? Because you use it to report your unemployment income on your federal tax return. The IRS gets a copy too, so they know how much you received. If you had any withholding, you’ll report that on your tax return as well, which will count toward the taxes you’ve paid in for the year (just like the taxes withheld from a regular job’s paycheck). In short, the 1099-G is like a W-2 for unemployment: it documents your income and any taxes paid.

• State Unemployment Agency – This isn’t a form, but it’s worth clarifying. Unemployment benefits are administered by state agencies (for example, California’s EDD (Employment Development Department), New York’s Department of Labor, etc.), even though the tax treatment involves federal law. These agencies pay out the benefits and handle any tax withholding from those benefits. So, if you want to start or stop withholding, you do that through the state agency. They are also the ones who will issue your 1099-G. The U.S. Department of Labor provides oversight and funding guidelines for unemployment insurance programs, but each state runs the day-to-day operations. This state-federal partnership means your interactions (applying for benefits, requesting withholding) are usually with the state office, while the IRS deals with the aftermath on your tax return.

• Federal vs. State Income Tax – Keep in mind there are two levels of income tax that can apply to unemployment benefits: federal and state. Federal income tax applies nationwide (that’s the IRS and the 10% optional withholding we’ve been discussing). State income tax depends on where you live – some states tax unemployment benefits, others do not. We will cover the state-by-state rules in detail in a later section. For now, just know that “having federal tax withheld” won’t cover any state tax you might owe. States often allow a separate withholding for state income tax on your benefits (usually a percentage you can opt into as well). So, you might choose to have federal tax withheld, state tax withheld, both, or neither. Each is a separate choice. Generally, people will at least consider federal withholding because that rate is fixed at 10%. State withholding, if available, might have different rates or rules depending on the state.

• Taxable Income vs. Tax-Free – We use the term taxable to mean the money will be subject to income tax. Unemployment benefits are 100% taxable at the federal level (again, except for special one-time laws). This means every dollar counts as income that could increase your tax bill. There are no federal tax deductions or credits specifically for unemployment income itself (although your overall low income might qualify you for other tax breaks). When we say some states treat unemployment as “tax-free,” we mean those states have decided not to include unemployment benefits in their state taxable income. That doesn’t affect federal tax – it only means that in those particular states, you wouldn’t owe state income tax on your benefits. It’s important to distinguish federal vs. state treatment in this way.

These key terms and players – IRS, Form W-4V, 1099-G, state agency, federal vs. state tax – form the basic toolkit for understanding unemployment and tax withholding. With these concepts in mind, let’s move on to look at the pros and cons of having taxes withheld, and some examples to illustrate the impact on your finances.

Pros and Cons of Withholding Taxes on Unemployment Benefits

Choosing whether to withhold taxes from your unemployment checks is an important decision. Let’s weigh the advantages and disadvantages of withholding that 10% upfront. Below is a quick pros and cons breakdown to help you decide:

As you can see, the trade-off mostly boils down to short-term cash flow versus long-term planning. Taking the full benefit now (no withholding) gives you more money today but requires you to plan for a tax payment later. Withholding takes a slice out now, which can sting, but it greatly reduces the risk of a larger sting later.

For most recipients, the pros of withholding outweigh the cons. The immediate loss of 10% per check is often worth the peace of mind and financial safety net it provides at tax time.

However, consider your personal situation: if you absolutely need every dollar now to cover essentials, you might decide to forego withholding and handle the taxes later (perhaps using a tax refund from elsewhere or savings). Just be very careful with that route – it requires self-discipline to not spend the tax portion.

Next, we’ll look at some real-life examples to illustrate what can happen in different scenarios, and then dive into what to avoid and how state taxes come into play.

Real-Life Examples: Withholding vs. Not Withholding in Action

Sometimes it helps to see the numbers. Here are a few simplified scenarios that show how withholding federal tax from unemployment benefits (or not withholding) can affect you at tax time:

Example 1: John – Withholding and No Surprise Bill
John is laid off and receives $400 per week in unemployment benefits. He opts to have federal tax withheld.

Each week, $40 (10%) is taken out, and John gets $360. Over 25 weeks, John received $10,000 in benefits (25 × $400), but he only saw $9,000 after withholding, while $1,000 went to the IRS. At year’s end, John’s Form 1099-G shows $10,000 in unemployment compensation and $1,000 in federal tax withheld.

Let’s say John had no other income. Roughly, John’s federal tax on $10,000 might be around $1,000 (assuming a 10% tax bracket for simplicity). Thanks to the withholding, he’s already paid that $1,000. When he files his tax return, he reports the $10,000 income and the $1,000 withheld – and ends up owing $0 additional tax.

If John qualifies for any credits (for instance, a tax credit for health insurance or something due to low income), he could even get a refund. The key point: because he chose withholding, John avoided owing money. The tax was painlessly paid during the year.

Example 2: Emily – No Withholding and a Tax Bill
Emily also gets $400 per week in unemployment, but she decides not to withhold any taxes. She receives the full $400 each week. Over 25 weeks, she collects $10,000 in total (and got to spend all $10k as it came). However, come tax time, Emily now has to report $10,000 of income with $0 paid in to the IRS.

If her tax on that amount is $1,000 (again assuming a 10% effective rate for comparison), she will owe $1,000 when filing her return. If Emily hasn’t set aside money, this could be a scramble. Maybe she finds she can’t pay it all at once – she might then have to set up a payment plan with the IRS or use a credit card, incurring interest.

Moreover, if Emily had other income during the year (say she worked part of the year and already had some withholding from that job, but not enough to cover the unemployment earnings), the $1,000 due could potentially include an IRS underpayment penalty if her total tax owed is high relative to what was prepaid. In short, by not withholding, Emily enjoyed more cash flow during unemployment, but ended up with a surprise tax bill and added stress later.

Example 3: Maria – No Withholding but Planned Ahead
Maria also foregoes withholding on $10,000 of benefits, like Emily. But Maria takes a disciplined approach: each week when she gets her $400, she immediately transfers $40 into a savings account for taxes. By the end of 25 weeks, she has $10,000 income and has $1,000 sitting in savings earmarked for taxes.

When tax time comes, she uses that $1,000 to pay her tax bill. The result is similar to John’s (no balance due to IRS), but the difference is Maria had to actively save that money herself. Essentially, she manually did what withholding would have automated.

This example shows it is possible to manage without withholding if you’re very organized. But realistically, it’s hard for many people to set aside money consistently when budgets are stretched thin. One emergency expense or moment of forgetfulness, and you might dip into those savings. That’s why, for convenience and caution, many prefer the withholding route.

Example 4: David – Back to Work Mid-Year
David was on unemployment for the first 4 months of the year, then found a new job. While unemployed, he didn’t withhold taxes. Once employed, he realized he might owe taxes on the $8,000 of benefits he got. David decided to adjust his new job’s Form W-4 to have extra withholding from his paychecks for the remainder of the year to cover the tax on that $8,000.

He calculated roughly what the tax would be (maybe $800) and distributed that extra amount across his remaining pay periods. This strategy works if you gain employment and have enough time to compensate, but it requires some tax knowledge and math. If David miscalculates, he could still end up short. It’s a bit complex, but it’s an example of an alternative to having had taxes withheld from the unemployment itself. Essentially, David shifted the withholding burden to his wage income later.

These examples illustrate a common theme: withholding on unemployment benefits usually means less drama at tax time. Not withholding isn’t fatal – you can plan or adjust as Maria and David did – but it requires effort and financial discipline. Many folks like John find withholding simplest, while folks like Emily learn the hard way that not withholding can lead to a tax bill.

Now that we’ve seen what can happen, let’s highlight some critical mistakes to avoid when handling taxes on unemployment income.

Avoid These Pitfalls When Paying Taxes on Unemployment

It’s easy to slip up when you’re dealing with new tax situations. Here are some common mistakes and misconceptions to avoid:

• Assuming Unemployment Benefits Aren’t Taxed: A big mistake is thinking that because it’s “unemployment assistance,” it must be tax-free. Wrong! Unemployment compensation is taxable at the federal level (and in most states). Don’t fall into the trap of spending all your benefit money without realizing a portion will likely belong to the IRS. Always treat your unemployment checks as income that will need taxes paid.

• Not Opting In (and Forgetting to Save): If you choose not to withhold taxes from your benefits, don’t just hope for the best. A mistake is cashing those full checks and not setting aside money for taxes. If you go this route, you must proactively save a portion of each payment or make quarterly estimated tax payments to the IRS. Neglecting this will set you up for a painful bill later. Many people regret not having at least the 10% withheld because they end up with nothing saved when taxes come due.

• Ignoring State Taxes: Federal withholding is one issue, but don’t forget about state income tax. Depending on your state, you might owe state tax on your unemployment benefits too. A mistake is assuming “I withheld 10%, I’m covered” – that 10% is only for federal tax. Check if your state taxes unemployment (we’ll provide a state-by-state table shortly). If it does, consider having state tax withheld or plan to pay it. Ignoring state tax can lead to another surprise bill from your state’s revenue department, separate from the IRS.

• Waiting Too Long to Adjust: Some people realize only late in the year (or after getting a new job) that they haven’t paid any tax on their unemployment income. If you’ve gone without withholding for a while, it’s a mistake to just continue and “deal with it later.” Instead, take action when you realize it. You can start withholding at any time by submitting Form W-4V to your unemployment office – don’t think it’s “too late” mid-year. Even withholding on your remaining benefits is better than nothing. Alternatively, start making estimated tax payments as soon as you realize you might owe. The longer you wait, the harder it is to catch up without penalty.

• Filing Taxes Incorrectly: Come tax time, make sure you report your unemployment benefits properly. One error to avoid is forgetting to include your Form 1099-G info on your tax return. Some people miss the form or don’t know that unemployment counts as income to report. The IRS gets that info, and if you fail to report it, it can trigger a notice or audit. Also, if you had withholding, remember to claim that on your return so you get credit for the taxes you paid in. Basically, use your 1099-G carefully: enter the benefits as income and the withholding as taxes paid. It’s an easy part of the return to mess up if you’re unfamiliar.

• Thinking Unemployment “Doesn’t Count” for Credits: This is a nuanced one. Unemployment benefits are not considered “earned income” for certain tax credits, like the Earned Income Tax Credit (EITC). A mistake here is expecting a big EITC or other earned-income-based credit from unemployment income. If 2025 is a low-income year because you were unemployed, you might think you’ll get a large EITC. But unemployment doesn’t count toward that credit – in fact, if unemployment replaced what would have been wages, you could end up with less EITC. This isn’t directly about withholding, but it’s a related tax surprise to avoid: don’t rely on unemployment income to boost credits or refunds. Plan for possibly lower credits, meaning the tax owed on unemployment might not be offset as much as you hoped.

• Not Communicating with Your State Agency: If you decide to start or stop withholding, make sure you properly submit the request and confirm it’s in effect. Don’t just verbally assume it’s handled. Use the correct form or online system as instructed by your state. A mistake would be telling an agent “yes, withhold taxes” over the phone and not following up, only to find out later it wasn’t implemented. Always check your payment stubs or online account to see if the withholding is actually happening (look for that 10% deduction labeled as federal tax). Administrative errors happen, so keep an eye on it.

Avoiding these pitfalls will ensure that you’re on top of your unemployment taxes and won’t face an avoidable financial crisis later. Next, let’s discuss how unemployment taxes differ by state, as that can be a major factor in your planning.

Federal Rules vs. State Rules: What You Need to Know

We’ve talked a lot about federal tax on unemployment benefits – which applies to everyone in the U.S. by the same rules. Now it’s time to address state taxes, which vary widely. The federal government gives all unemployment recipients the choice to withhold 10% for federal taxes, but each state has its own approach to taxing unemployment benefits at the state level.

First, the Federal Rules Recap:

• Taxability: All unemployment compensation is taxable by the federal government (unless Congress passes a special exemption, like they did for one year during COVID-19).

• Rate and Withholding: There’s no separate “unemployment tax rate” you pay – it just gets added to your regular income and taxed according to your federal tax bracket. The 10% withholding is simply a flat portion to cover your eventual tax. Some people might ultimately owe a bit more than 10% (if you fall in a higher tax bracket), while others might owe less (if in a lower bracket). The IRS doesn’t allow adjusting that percentage for unemployment; it’s fixed at 10% if you opt in.

• How to Withhold: Use Form W-4V or your state’s unemployment benefits portal to elect withholding. It remains in effect until you stop it or until your benefits end.

• Estimated Taxes Alternative: If you choose not to withhold or if 10% isn’t enough for you (say you have other income pushing you into a higher bracket), the IRS expects you to make quarterly estimated tax payments to cover the difference. You can use Form 1040-ES to calculate and send these. The key deadlines are usually April 15, June 15, September 15, and January 15 of the following year. Missing these can result in penalties, so plan accordingly.

• Special Cases: The only recent special case was for tax year 2020, where the American Rescue Plan Act allowed up to $10,200 of unemployment benefits to be excluded from income for certain taxpayers (one-time pandemic relief). That was an exception, not the norm. As of now (2025), unemployment benefits have no exclusion – they are fully taxable again. So don’t bank on any portion being tax-free federally under current law.

Now, onto State Tax considerations. Whether you owe state income tax on your unemployment benefits depends on where you live (or more specifically, your state of residence/tax filing). Here are the general scenarios:

• States with No Income Tax: Some states simply do not have state income tax on wages or any personal income. If you live in one of these states, you won’t owe any state tax on unemployment, because there’s no state income tax at all. (Examples include Florida and Texas, among others.) For these states, the whole state tax issue is moot – you only worry about federal tax. There’s no option (and no need) to withhold state tax from your benefits since the state doesn’t levy it.

• States that Exempt Unemployment Benefits: A handful of states do have an income tax, but they specifically exempt unemployment benefits from that tax. In those states, your unemployment is state-tax-free even though other income (like wages) might be taxed. For instance, California, which normally has income tax, does not tax unemployment benefits at the state level. So a California resident would owe federal tax on their benefits, but zero state tax. These states often have this policy to give a break to unemployed individuals. If you’re in one of these, you also don’t need to worry about state withholding (and usually the state won’t even offer to withhold because it’s not taxable).

• States that Tax Unemployment Benefits: The majority of states with an income tax treat unemployment benefits as fully taxable income, just like the feds do. That means you’ll owe state income tax on the benefits according to your state’s tax rates. Many of these states allow you to request state tax withholding from your benefits (often a flat percentage similar to federal, but it might differ by state). However, not all do it automatically – you might have to opt in separately. If you expect to owe a significant amount of state tax, it’s worth arranging withholding or saving for it, similar to federal.

• Local Taxes: A quick note – a few localities (like some cities or counties) have their own income taxes. Generally, if they tax regular income, they would tax unemployment benefits too. This is less common, but if you live in a place like New York City (which has a city income tax), you should consider that in your planning as well. Local taxes typically don’t offer withholding on unemployment specifically, so you might have to account for those in quarterly payments or at tax time.

To make this concrete, here’s a state-by-state table of unemployment benefit tax treatment and withholding availability. This will help you find your state and see if your benefits are taxable there and whether you might want to have state tax withheld:

How to use this table: If your state is listed as “No” – good news, you won’t owe state tax on your unemployment benefits, so you don’t need to have state tax withheld (and in many cases, you couldn’t even if you wanted to). If your state is “Yes,” that means your benefits are subject to state income tax just like your wages would be. Typically, the state will give you the option to withhold state tax from your benefits (often you specify this when you apply for benefits or via a state form). The withholding rate or method might vary – some states might take a flat percentage (like 5% or so) or let you choose an amount. Check with your state’s unemployment office website for instructions on state withholding if you want to do it. Otherwise, be prepared to pay the state tax when you file your state income tax return.

Note: States can change their tax laws, so always double-check current rules. As of now, the list above holds. For example, a recent change – at one point during the pandemic, a few states temporarily excluded some unemployment benefits from tax or offered relief, but those were temporary measures. The table reflects the normal rules.

Also, remember if you worked part of the year, state taxes on wages and unemployment will all be combined on your state return. If you had withholding at your job but none on unemployment, that state withholding from your job might or might not cover what’s owed on the unemployment. It’s another reason to consider state withholding if you have a long period on benefits.

Evidence & Insights: Why Withholding Is Often Wise

You might wonder, is it really that common to have problems if you don’t withhold? Let’s look at some evidence and expert insights:

• IRS Data on Underpayment: Many taxpayers each year incur underpayment penalties, and a portion of those are due to people not realizing they needed to pay taxes on unemployment or other untaxed income. The IRS doesn’t break out a public statistic for “unemployment tax penalties” specifically, but anecdotal evidence from tax preparers after 2020 indicated a spike in folks owing money because of unemployment income. The year 2020 was extreme – millions got benefits and many did not withhold, leading to widespread confusion. The IRS’s own Taxpayer Advocate Service issued advisories urging people on unemployment to opt for withholding or make estimated payments to avoid trouble. This shows that even the IRS anticipated and tried to prevent the issue – a clear sign that they expect you to manage those taxes throughout the year.

• Expert Advice: Financial advisors and tax professionals generally recommend withholding on unemployment. The reasoning is straightforward: it’s hard for someone unemployed to save money for taxes because, by definition, they’re already in a financial pinch. “Avoid a tax-time surprise” is a common refrain. This advice isn’t just theoretical – many preparers have seen clients shocked to owe a thousand or more in April simply because no taxes were taken from their unemployment checks. As one tax expert put it, “Unemployment benefits are taxable, and the IRS doesn’t care that you were out of work – they still expect their due. Plan accordingly.” It may sound harsh, but it’s the reality.

• Court Rulings and Legal Status: The taxability of unemployment benefits is well-established in law. Congress made these benefits fully taxable in 1986, and there has been no reversal since. Courts have consistently upheld the IRS’s stance that unemployment compensation is income. For instance, the U.S. Tax Court has ruled against individuals who tried to argue that their unemployment benefits shouldn’t be taxed – such arguments don’t fly because the law is explicit. The legal consensus is clear: if you receive unemployment, it’s income and must be reported and taxed. Even the U.S. Supreme Court indirectly touched on unemployment in a famous 1937 case (Steward Machine Co. v. Davis), which upheld the unemployment insurance system (essentially affirming that the government can collect and distribute funds for unemployment – which by extension affirms it can tax and regulate those funds). While that case was more about funding the system via employer taxes, it set the stage that unemployment compensation is part of the taxable economic system. In short, there’s no loophole to make unemployment benefits tax-free (aside from legislative grace like the one year ARPA exclusion). Trying to avoid or evade the tax can lead to legal trouble, so it’s best to comply and plan accordingly.

• Economic Insights: From a policy perspective, why are unemployment benefits taxed? The idea is to treat all forms of income similarly, as taxing some and not others creates unfair situations. In the 1970s and 80s, economists like Martin Feldstein argued that untaxed benefits could disincentivize people from finding work quickly. Whether or not that’s true, Congress decided that unemployment should be taxed like wages to maintain fairness and encourage consistency. So, the taxation isn’t an accident – it’s an intentional part of the system. Knowing this can perhaps lessen the sting: you’re not being singled out; everyone on unemployment is in the same boat of having taxable benefits.

• Statistics: Let’s consider a rough statistic: Suppose you received $20,000 in unemployment benefits over a year (which is not uncommon for a prolonged unemployment spell). If you are in a 12% federal tax bracket, you’d owe about $2,400 in federal tax on that if you did nothing. If you had 10% withheld, you’d have paid $2,000 of it during the year, leaving maybe a $400 difference to settle (which could be further reduced by any credits or deductions). If you had nothing withheld, coming up with $2,400 at once might be very challenging when you’ve been out of work. This simple math is why even many personal finance books recommend withholding. It’s a form of forced savings to cover an inevitable obligation.

In summary, all signs point to the wisdom of withholding: the IRS expects it, experts advise it, and the legal framework supports it. It aligns with the principle of paying taxes as you receive income, which is fundamentally how our system is designed to work.

Now, let’s wrap up with a few more comparisons of approaches and a final FAQ to address lingering questions you might have.

Comparing Your Options: Pay Now vs. Pay Later vs. Other Strategies

To crystallize your decision on withholding, it helps to compare the main ways to handle the taxes on unemployment benefits:

• Option 1: Withhold Now (Pay as You Go) – This is the route we’ve focused on. You fill out Form W-4V and have 10% of each benefit payment sent off to the IRS. Pros: It’s automatic and consistent; you’re likely covered or close to covered for taxes; low stress at tax time. Cons: You get less in each unemployment check; if you end up not owing much, you’ll have to wait for a refund of the excess. This option is best for those who want simplicity and safety. It aligns with the typical taxpayer behavior of withholding from paychecks.

• Option 2: Pay Later in One Lump Sum – This means no withholding, use the full benefits for now, and then pay whatever tax is due when you file your annual tax return (by April of the next year). Pros: You keep more money in hand during your unemployment period, which can be crucial for immediate needs. Cons: Risk of not having the money when needed; possible IRS penalties if the amount owed is large; requires willpower to save money on your own. This option can work if the unemployment period is short or the amount is small (so the tax won’t be huge) or if you know you have other funds to cover the tax. It’s essentially delaying the inevitable. It’s only recommended for those who are very confident in managing the upcoming tax bill.

• Option 3: Make Estimated Quarterly Payments – Instead of withholding, you proactively send tax payments to the IRS every quarter to cover the unemployment income (and any other income you have without withholding). You would calculate roughly what you owe and pay in four installments during the year. Pros: You remain compliant with the tax “pay-as-you-go” requirement, potentially avoiding penalties even without withholding; you have use of the money until each quarterly due date rather than losing 10% every week. Cons: It’s manual and requires calculating and meeting deadlines; easy to miss a payment if you’re not organized; if your estimates are off, you could still owe more. This is often used by self-employed individuals or others without wage withholding. If you’re comfortable with that system (maybe you’ve been self-employed before), you could apply it here. For example, if you know you’ll receive roughly $12,000 in benefits over Q2 and Q3 of the year, you might send $1,200 to the IRS by the June and September quarterly deadlines respectively (assuming 10% needs to be paid). It’s a bit of a hassle, but it’s a way to avoid the big year-end hit while not reducing each benefit payment as it comes.

• Option 4: Adjust Other Withholding – If you or your spouse (if married filing jointly) has other income with withholding, you can increase withholding on that other income to cover the taxes on your unemployment. For example, if your spouse is working, they can file a new Form W-4 at their job to have an additional $X withheld each pay period to cover your unemployment’s tax. Pros: Achieves the same end result (tax paid in) without touching the unemployment checks; could be efficient if the working spouse’s payroll system can easily adjust. Cons: Relies on having other income; might complicate the other person’s withholding and potentially lead to them overwithholding if not tuned correctly; coordination required. This is a more advanced strategy but can be convenient for some households. Essentially, the household as a whole ensures enough tax is withheld from one source or another.

• Option 5: Combo Approach – Some people might do a mix: e.g., withhold federal 10% but not state (and then pay state later or vice versa), or withhold for part of the year and then stop (or start mid-way). These systems can get confusing, but it’s possible. For instance, if you didn’t withhold for the first few months but then realize you should, you can start withholding for the remainder. Or you might choose to have federal withheld but not state, reasoning that your state tax might be smaller or zero. Pros: Some flexibility to tailor what’s withheld. Cons: Partial measures can lead to partial surprises – if not fully covered, you’ll still owe something, just less. If you stop withholding too early and then continue to receive benefits, you might undermine the benefit of having started it.

In comparing these, ask yourself a few questions: Do I trust myself to save and pay later? If not, lean toward withholding or estimated payments. How hard will coming up with the lump sum be for me? If very hard, definitely try to handle it incrementally now. Am I expecting another job or other income this year? If yes, that opens up the option to adjust that income’s withholding or use that income to pay any tax due.

For many people, Option 1 (withholding from unemployment itself) is the simplest and least worrisome. Option 2 (pay later) is the riskiest unless the tax will be minimal or you have a plan. Option 3 (estimated payments) is a middle-ground if you’re disciplined and maybe already familiar with paying taxes that way.

No matter which route, keep records. If you do estimated payments, keep receipts or confirmations of those payments. If you adjust a W-4 or do something creative, make notes so you remember at tax time why more was withheld elsewhere, etc.

Finally, let’s address some frequently asked questions that often come up on this topic.

FAQ: Frequently Asked Questions about Unemployment and Tax Withholding

Q: Are unemployment benefits really taxable by the IRS?
Yes. Unemployment benefits are considered taxable income by the IRS, just like wages. You must report them on your federal tax return and pay income tax on them unless a specific law exempts them (which is rare).

Q: Do I have to have taxes withheld from my unemployment checks?
No, it’s not mandatory. Tax withholding on unemployment is voluntary. However, if you choose not to withhold, you are still responsible for paying the tax later. Opting in just makes it easier to fulfill that obligation.

Q: What percentage will be withheld if I opt in?
Federal withholding from unemployment is a flat 10% of your benefit payments. This rate is set by federal law. (For state withholding, the percentage can vary by state.) You cannot choose a different percentage for federal.

Q: How do I set up tax withholding on my unemployment benefits?
You typically request it through your state’s unemployment office. This can often be done when you first apply for benefits (there might be a checkbox or question about withholding). If you’re already receiving benefits, you can submit Form W-4V (Voluntary Withholding Request) to the agency or use their online system to start withholding. Always follow your state’s specific instructions.

Q: Can I stop or change the withholding later?
Yes. Withholding is not permanent – you can adjust it. To stop it, you would submit a new request (again via Form W-4V or state form) indicating you no longer want tax withheld. To restart it, you do the same. Changes will affect future payments. There might be some processing time, so don’t expect instant changes overnight.

Q: What if I already received a bunch of unemployment without withholding?
You have a few options. You can start withholding going forward to at least cover the rest of the year. And for the past payments, you might consider sending an estimated tax payment for the quarter in which you received that money, to catch up. If that’s not feasible, just be prepared to pay the tax when you file. You won’t be penalized as long as by year-end you’ve paid enough through any combination of withholding or estimates (generally at least 90% of your total tax due). If you’re behind, you might face a small penalty, but it’s usually not huge unless the amount is very large.

Q: My unemployment was only for a month or two. Do I need to bother with withholding?
If it’s a very short period and a small amount, the tax owed on it might be minimal. In such cases, some people choose not to withhold, figuring they can cover a small tax bill. That’s fine. Just remember to include that income on your tax return. If in doubt, it never hurts to withhold – you can always get it back as a refund if it turns out to be unnecessary.

Q: Are unemployment benefits taxed by my state?
It depends on the state. Many states do tax unemployment benefits, but some don’t (either due to no state income tax or a specific exemption). Check the state-by-state list above for your state. If your state does tax them, you might owe state tax as well, and you may have the option to withhold state tax from your benefits.

Q: I live in a state with no income tax. Should I still withhold federal tax?
Yes, if you determine it’s appropriate for you. The absence of state tax doesn’t change your federal tax situation. Federal withholding is still typically wise unless you have other plans to pay the tax later.

Q: Will I get a refund if I over-withhold on my unemployment benefits?
Yes. If you end up withholding more than the actual tax you owe (for instance, maybe you withheld 10% but your effective tax rate turned out to be 8% because of deductions), the IRS will refund the excess to you after you file your tax return. Withholding more just means a bigger refund. While some people prefer not to give the IRS an “interest-free loan,” others don’t mind because it guarantees they didn’t underpay.

Q: What if I can’t pay the tax I owe on unemployment?
If you do find yourself with a tax bill you can’t fully pay, don’t panic. The IRS offers payment plans. You can file your return, pay what you can, and request a payment plan for the rest. You’ll incur some interest and late payment penalties, but it’s manageable. The key is to file on time even if you can’t pay in full – that avoids the harsher failure-to-file penalty. For state taxes, states also usually have arrangements for payment plans. Of course, this situation is exactly what withholding aims to prevent, so it’s better to withhold or pay in during the year if possible.

Q: Does receiving unemployment affect my taxes in other ways?
Aside from owing income tax on it, unemployment benefits can have some indirect tax effects. As mentioned, they don’t count as “earned income” for credits like the EITC. They also aren’t subject to Social Security or Medicare taxes (FICA) – which is one reason your benefit amount is not reduced for those taxes. This means you won’t pay into Social Security/Medicare during the period you’re on unemployment, which is fine (it doesn’t create a tax liability, it just means that time doesn’t contribute to those programs). When filing, unemployment is reported on its own line (Schedule 1 of the 1040). If you had health insurance through the marketplace (ACA), note that unemployment income does count in calculating any premium tax credit eligibility. These are just things to be aware of, not necessarily withholding issues.

Q: I heard something about $10,200 being tax-free for unemployment – what was that?
This refers to a one-time provision in the American Rescue Plan Act of 2021. For the tax year 2020 only, Congress allowed up to $10,200 of unemployment benefits per person to be excluded from federal taxable income (for those under certain income thresholds). That was pandemic relief and does not apply now. It caused some confusion because people initially paid tax on 2020 benefits and then got refunds after the law change. But after that year, unemployment benefits went back to fully taxable. Unless new legislation is passed in the future, you should assume all your unemployment is taxable. So don’t expect any automatic $10,200 exclusion or similar unless the law changes again.