Unemployment Taxes
Ted S. Warren  /  AP
Eric Victorson, shown in his home in Issaquah, Wash., lost his job last October. He was surprised to find out that his unemployment benefits were subject to tax.
updated 3/6/2009 1:22:31 PM ET 2009-03-06T18:22:31

Some Americans are learning a jarring lesson about unemployment as they prepare their tax returns.

At a time when the newly laid-off are swelling unemployment rolls to record numbers, the painful surprise for many is that jobless benefits are taxed like income. That leaves many on the hook for hundreds or thousands of dollars because the taxes aren't automatically withheld from benefit checks.

To make things worse, some people also are hit with a state unemployment tax bill.

The tax is no government secret — unemployment benefits have been fully taxable for more than 20 years. But many complain that they aren't properly informed about the tax or the fact withholding isn't automatic.

The economic stimulus program will temporarily ease the impact by eliminating federal income taxes on the first $2,400 of unemployment benefits received this year. It's a one-shot break, though and the boost may last for just a few weeks.

The exclusion won't immediately help people who lost their jobs last year, like Eric Victorson of Issaquah, Wash., who was "dumbfounded" to learn the impact of taxes.

The 35-year-old business systems analyst was laid off in October, forcing him to get by on a $541-a-week unemployment check after making three times that from Microsoft Corp.

He didn't realize the tax jolt he'd get until this year. What would have been a $2,900 refund was whittled to $1,400 — halving an amount he needs to help him get by while he looks for a new job.

"I knew I'd have to pay something, but to think I was going to get gouged $1,500 for three months' unemployment," he said. "What if I was out the whole year?"

Unemployment taxes netted $7.2 billion for the federal government in fiscal 2008 and $32.4 billion for state governments, according to the Department of Labor. But tax expert Tom Ochsenschlager said taxing unemployment is "a silly rule" whose impact on the jobless is magnified during a recession.

"Historically maybe (taxation) hasn't been a huge disadvantage for families," said Ochsenschlager, vice president of tax for the American Institute of Certified Public Accountants. Taxing unemployment benefits right now, he said, is "trying to get blood out of a turnip."

Major Market Indices

Unemployment compensation typically ranges between roughly $100 and $400 a week, varying depending on recent pay level, state of residence and other factors.

Those seeking to minimize tax-time problems can request that income taxes be withheld from their unemployment checks or simply set money aside to make sure they can pay the taxes by April 15, if it's feasible. But that may be difficult, since, as Victorson noted, "the money barely is enough to survive on as it is."

Inna Shaulskaya, a 29-year-old New Yorker who was laid off from her job as a sales planner in November, learned about the taxes and signed up for withholding. But even with getting the maximum $405 a week for New York state, subtracting the taxes doesn't leave her enough to avoid tapping an emergency fund to pay her mortgage.

Taxing unemployment benefits, she said, is "not logical whatsoever."

"It's actually funny in a way: 'We'll help you out with the unemployment benefits and then we'll take some back!'" she said. "It would make better sense if they just paid less."

It hasn't always been this way. Unemployment compensation was tax-free until 1979, when the government made it partly taxable. The move came after some policy studies found tax-free paychecks reduced the incentive to find a job.

Congress then made benefits fully taxable in 1987. The $787 billion economic stimulus package signed into law last month is the first time since then that the tax has been even temporarily eased.

The 2009-only change wasn't enough for some, however.

"Taxing those seems like a really crazy practice to me," said U.S. Rep. Virginia Foxx, R-N.C., who is sponsoring legislation to get rid of all federal income taxes on unemployment benefits. "It's like giving with one hand and taking with another. I just think it's unfair to tax the benefits of these people who are struggling to find work, particularly in a difficult economic time."

Foxx admits, however, that chances for her legislation passing in this environment are not strong.

The problem for some consumers stems from how they are notified about the taxes. States are required to offer the option of withholding federal income taxes from unemployment checks. But each state determines how to do that.

Karen Brunke, 41, who was laid off as a purchasing manager twice last year by ailing manufacturing firms, said she "came to a screeching halt" when she read the fine print on her unemployment benefits form and saw the tax warning.

"If I hadn't stopped and read that, I would have ended up owing a lot," said the Coatesville, Pa., resident, who was out of work five months before finding work at a pharmaceutical company.

After the surprise wore off, she was annoyed at the concept of unemployment taxes.

"When my father was laid off in the mid-'70s, they didn't have to pay taxes on that. So if it was good enough for my father's generation, why isn't it good enough for mine?" she asked. "I feel like I'm getting screwed."

Copyright 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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