Navigating the IRS Guidance on Unemployment Compensation Exclusion: Tara's Tax Tips

Navigating the IRS Guidance on Unemployment Compensation Exclusion: Tara's Tax Tips

Hello, fellow taxpayers! I'm Tara Fisher, your trusted tax expert from Vishal, here to guide you through the recent IRS guidance on unemployment compensation exclusion under the American Rescue Plan Act of 2021 (ARPA). Whether you've already filed your return or not, this information is crucial for maximizing your tax benefits. So, let's dive into the details and explore the new Unemployment Compensation Exclusion Worksheet together.

Understanding the Unemployment Compensation Exclusion

Under normal circumstances, unemployment compensation is considered part of a taxpayer's total income. However, the ARPA introduces a significant change. It allows individuals to exclude the first $10,200 of unemployment compensation from their 2020 income, provided their modified adjusted gross income for 2020 is less than $150,000. If you're filing jointly, each spouse receiving unemployment compensation gets a $10,200 exclusion.

Now, let's address the two scenarios: for those who have already filed a return and those who haven't.

For Those Who Have Already Filed a Return

ARPA came into effect after many taxpayers had already filed their returns, creating a dilemma. The IRS advises against filing amended returns for the tax advantages of the exclusion. Instead, the IRS will recompute your taxes using the unemployment compensation exclusion and adjust your account accordingly. Any resulting refund will be sent directly to you.

For Those Yet to File a Return

If you haven't filed yet, the IRS provides clear guidance on reporting the unemployment exclusion separately. Report it as a deduction on Form 1040, Schedule 1, Part 1, line 8, labeled "Other Income."

When you receive Form 1099-G showing your total unemployment compensation for 2020, report this amount on Form 1040, Schedule 1, Part 1, line 7. Some states issue separate Forms 1099-G for state unemployment compensation and the additional $600 per week from federal unemployment compensation; combine these amounts.

Understanding the IRS Guidance on Deductions and Exclusions

The IRS guidance extends beyond the unemployment exclusion itself. The total unemployment compensation reported on line 7 impacts various deductions and exclusions, including:

  • Taxable social security benefits
  • IRA deduction
  • Student loan interest deduction
  • Nontaxable amount of Olympic or Paralympic medals and USOC prize money
  • Exclusion of interest from Series EE and I U.S. Savings Bonds
  • Exclusion of employer-provided adoption benefits
  • Tuition and fees deduction
  • Deduction for active participation in a passive rental real estate activity

Contributions to a governmental unemployment compensation program or governmental paid family leave can reduce the amount reported on line 7 if you aren't itemizing deductions. If you repaid an overpayment of unemployment compensation in 2020, subtract that amount from the total and note it next to line 7.

Introducing the Unemployment Compensation Exclusion Worksheet

To assist taxpayers in computing their modified gross income and the exclusion amount, the IRS has introduced the Unemployment Compensation Exclusion Worksheet. Here's a step-by-step guide:

  • Enter the total of lines 1 through 7 of Form 1040 or 1040-SR (or lines 1a, 1b, and 2 through 7 for Form 1040-NR).
  • Enter the amount from Schedule 1, lines 1 through 6, excluding any unemployment compensation from Schedule 1, line 7.
  • Use the instructions to determine the amount to include on Schedule 1, line 8, without reducing it by the unemployment compensation exclusion.
  • Add lines 1, 2, and 3.
  • Enter the amount from line 10c (for Form 1040 or 1040-SR) or line 10d (for Form 1040-NR).
  • Subtract line 5 from line 4; this is your modified adjusted gross income.
  • If the amount on line 6 is $150,000 or more, you can't exclude any unemployment compensation.
  • Enter the amount of unemployment compensation paid to you (up to $10,200) and your spouse if filing jointly.
  • Add lines 8 and 9; this is the excluded amount.
  • Subtract line 10 from line 3 and enter the result on Schedule 1, line 8. If it's less than zero, enter it in parentheses. On the dotted line next to Schedule 1, line 8, write "UCE" and show the exclusion amount in parentheses.

Staying Informed for Accurate Tax Preparation

Keeping abreast of IRS updates is crucial for accurate tax preparation, and understanding the nuances of unemployment compensation exclusion is no exception. Tara Fisher, with over 20 years of tax experience, emphasizes that the information provided here is for informational purposes only and not tax advice. For personalized advice, consult a tax advisor who can guide you based on your specific situation.

Stay tuned to the Vishal blog for more insights into the latest tax updates that matter to you. And for a deeper dive into ARPA tax provisions, check out John Stevko's recap.

Remember, the world of taxes is ever-evolving, and staying informed is your key to navigating it successfully. Happy tax season!

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