Are My 2021 Unemployment Benefits Tax-Free?

Many Americans were unemployed last year. Do you get a tax break on that income?

Although the joblessness situation wasn't nearly as dire in 2021 as it was in 2020, many people still wound up collecting unemployment benefits last year -- especially earlier on, before the economy began to pick up and vaccines became more widely available. If you received unemployment benefits in 2021, you may be wondering how they might impact your upcoming tax return.

In fact, you may have heard that unemployment benefits aren't subject to taxes during the pandemic. But while that was true at one point, it's not the case if you received benefits last year. It's important to know the rules so you can properly complete your 2021 tax return, which is due on April 18.

A limited tax exemption

The American Rescue Plan was signed into law in March 2021, and its purpose was to provide widespread relief at a time when the pandemic was still raging and we didn't have tools like widely available vaccines to offer protection. That relief package resulted in a host of positive changes. It sent $1,400 stimulus checks into Americans' bank accounts, it enhanced the Child Tax Credit, and it boosted unemployment benefits for a large chunk of 2021.

Another thing the American Rescue Plan did was exempt up to $10,200 of unemployment compensation from taxes for the 2020 tax year. Jobless workers who collected benefits the first year of the pandemic got a nice financial break as a result.

But the American Rescue Plan did not create a tax exemption for unemployment benefits collected in 2021. If you received unemployment last year but you didn't arrange to have taxes on that income withheld upfront, then you'll need to reconcile what you owe when you sit down to file your 2021 tax return.

That said, even if you collected unemployment last year and had no tax withheld, that doesn't guarantee you'll be writing the IRS a check this tax season. Maybe you had too much tax withheld while you were still working, so while you owe money on your unemployment income, the amount is offset by the taxes you already had withheld.

Or, it may be that you're entitled to enough tax credits that you're able to offset your unemployment tax liability. Either way, you won't know until you run the numbers and look at the big picture.

It pays to get help

The 2021 tax year was complicated for a lot of people. Many workers shifted from being salaried to venturing out as freelancers, and many took on side jobs to generate extra income. Plus, a lot of people collected unemployment benefits in the absence of having a job.

If you're not sure how to go about filing your 2021 taxes, it pays to consider hiring a professional to get the job done. If your taxes aren't overly complicated -- meaning, you don't own a business or multiple properties, for example -- then the fees you're charged may be fairly minimal. In exchange, you'll get peace of mind knowing you're doing your taxes correctly and aren't paying the IRS a penny more -- or collecting a penny less -- than you should be.