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Hundreds of unemployed Kentucky residents wait in long lines outside the Kentucky Career Center for help with their unemployment claims.John Sommers II

Individuals receiving unemployment benefits this year could face a tax surprise in 2021: owing Uncle Sam or receiving smaller refunds.

Some 1.43 million people filed for unemployment last week, according to the U.

S. Labor Department.

More uncertainty is ahead: The $600 weekly federal unemployment boost ended on July 31 and Congress hasn't agreed on an extension of benefits.

While the additional unemployment income has helped millions of families get by, it can carry some unintended tax consequences that will surface next year.

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"A big concern for a lot of people is that  unemployment is taxable, especially for people who get a huge amount and don't have withholding from other sources," said Ann E. Kummer, CPA and partner at Kirshon & Co. in Poughkeepsie, New York.

"They could end up with a tax bill next year, and if we're not in a better position economically, they'll be hurting," she said.

Short on withholdingVIDEO2:5502:55How unemployment benefits are taxedInvest in You: Ready. Set. Grow.

Unemployment benefits are subject to federal income taxes, as well as state income taxes depending on the state where you reside.

That's where withholding comes in. If you fill out Form W-4V, you can have 10% of your payment set aside for federal income taxes.

You can also opt to pay estimated taxes quarterly. The first and second quarters' payments were due on July 15. Sept. 15 is the deadline for the third quarter, and Jan. 15 is the due date for the fourth quarter.

Failure to withhold enough tax could mean that unemployment recipients will owe Uncle Sam — or receive a smaller refund — next spring when they file.            

Losing tax creditsMladen Sladojevic | E+ | Getty Images

Low-income households face another problem, aside from falling short on withholding.

"The people who normally live paycheck to paycheck but are now making more money on unemployment are going to lose those earned income tax credits," said Adam Markowitz, enrolled agent at Howard L Markowitz PA CPA in Leesburg, Florida.

For the 2020 tax year — the taxes you'll be filing next spring — the maximum earned income tax credit can range from $538 for households with no qualifying children to $6,660 for those with three or more kids.

What you get will depend on your filing status and your adjusted gross income.

For instance, single filers with no children can't earn more than $15,820 in 2020 to qualify (the cap rises to $50,594 in AGI for single taxpayers with three kids).

If a taxpayer's income jumps up dramatically, he or she may see a drastic decline in tax credits next year. See below for an example from Markowitz.

A single mother of a 12-year-old earns $25,000 a year. She has no withholding. In 2019, she received a refund of approximately $3,900, which includes the additional child tax credit -- the refundable portion of the child tax credit -- and the earned income tax credit.

• That same taxpayer earned $5,000 prior to the Covid-19 pandemic, but goes on unemployment for the remaining 36 weeks of the year. She receives $750 a week in unemployment benefits, and they're extended until the end of the year.

• She will get a refund of about $1,900. This includes the earned income tax credit and the additional child tax credit.

"Yes, she made an extra $7,000 in total income being on unemployment, but her net difference when filing taxes is about $2,000," said Markowitz.

Income that's suddenly too high could also affect accessibility to the tax credit on premiums  for individuals who buy health insurance on the exchanges, said Kummer. These credits offset the cost of coverage.

To qualify for a premium tax credit, your household income can be no more than 400% of the federal poverty line for your family size. In 2020, the federal poverty line is $12,760 for individuals ($26,200 for a family of four).

If a taxpayer's income exceeds the 400% of federal poverty line threshold, they are no longer eligible for the premium tax credit and will have to repay it.

"If the unemployment bumps your income too much, you get the credit to offset premiums and then you have to pay it back," Kummer said. "It can make next April very uncomfortable."

A patch in the House                                                                        Speaker of the House Nancy Pelosi, D-Calif., at her weekly news conference in the Capitol in Washington on July 9.Caroline Brehman | CQ-Roll Call, Inc via Getty Images

Withholding taxes could help avert the tax hit, but households that are squeezed and need every cent of their unemployment face a difficult choice.

"If you're receiving unemployment benefits and you're low-income, you'd want to make sure there's food on the table," said Oscar Vives Ortiz, CPA and member of the American Institute of CPAs' personal financial specialist committee.

"If you find out you may owe, you should go to your state's unemployment website and withhold 10%," he said.

But a policy fix might be what it takes to head off a messy tax season for millions.

The House sought to head off these tax hiccups in its HEROES Act, the $3 trillion coronavirus relief bill it passed in May.

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The HEROES Act would have extended the $600 federal weekly unemployment benefit through January 2021. It also would have allowed taxpayers with less earned income in 2020 to collect the earned income tax credit based on their 2019 earnings.

Unemployment benefits aren't considered earned income.

"When you calculate your 2020 earned income tax credit, if your 2019 earned income tax credit would've been larger, you'd have the option to take that credit," said Meg Wiehe, deputy executive director of the Institute on Taxation and Economic Policy.

"This is a situation where it's less about what the individual can do or what the family decides to do," said Wiehe. "It requires a policy solution."

Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.

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  • Unemployment
  • Government taxation and revenue
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Trump: Planned executive actions for coronavirus aid include payroll tax cut

President Trump announced that the White House is drafting executive actions to address expired unemployment insurance, eviction protections, and student loan relief, and to suspend payroll taxes, as congressional negotiations for coronavirus aid continue to drag.

Speaking to reporters Thursday, Trump said the orders could be signed Friday afternoon or Saturday morning. He said a legislative deal was still possible, however.

The president is traveling to Ohio, where he is expected to sign a long-awaited "Buy American" order requiring the government to buy essential medicines and medical supplies from U.S. manufacturers.

In a tweet before leaving the White House, Trump said he had instructed the White House to "continue working on an Executive Order with respect to Payroll Tax Cut, Eviction Protections, Unemployment Extensions, and Student Loan Repayment Options."

Trump has pressed repeatedly for a payroll tax cut, a move backed by outside economic adviser Stephen Moore, a Washington Examiner columnist, but among lawmakers, the cut is less popular.

A federal moratorium on evictions expired at the end of July, exposing tenants of more than 12 million rental units to eviction should they miss a payment. A $600-per-week supplement to unemployment benefits that passed as part of the CARES Act in March has also expired.

Negotiations on a potential fourth stimulus bill have been underway for nearly two weeks; however, Democrats and the White House remain "trillions" of dollars apart, White House chief of staff Mark Meadows and Treasury Secretary Steven Mnuchin said Thursday.

Meadows said Thursday that Trump would take executive actions on unemployment aid and evictions if a deal could not be reached by the end of the week. "At this point, either we’re going to get serious about negotiating and get an agreement in principle, or it becomes extremely doubtful that we’ll be able to make a deal if it goes well beyond Friday," he said.

Senate Majority Leader Mitch McConnell, a Kentucky Republican, said on Thursday that Democrats were to blame for the lack of progress and that the chamber would be in session Monday.

"The only thing that gets an outcome is the speaker and the president of the United States reaching an agreement," McConnell said on Fox News on Wednesday. "And once they do that, I believe that the majority of my members will support it, but not every single one of them. I’ve been clear about that from the beginning."

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