Unemployment compensation exclusion on 2020 returns
ARPA exempts the first $10,200 of unemployment compensation per person for 2020.
The American Rescue Plan Act (ARPA) excludes up to $10,200 of unemployment compensation from tax for 2020 only. For married filers, each spouse can exclude up to $10,200 of unemployment compensation.
The exclusion does not apply if modified adjusted gross income (MAGI) is $150,000 or more. The $150,000 limitation applies to all filing statuses.
Also, taxpayers use the full amount of unemployment compensation to figure MAGI for certain tax items, such as taxable social security benefits, the IRA deduction, and the exclusion for employer-provided adoption benefits.
How to report and claim the unemployment compensation exclusion
The IRS has issued post release forms changes with revised instructions for Schedule 1, Form 1040, Additional Income and Adjustments to Income.
The revised instructions include a worksheet to figure:
- MAGI (for purposes of the unemployment compensation exclusion), and
- the amount of unemployment to show as an exclusion on line 8 (other income).
Essentially, the full amount of unemployment compensation is reported on line 7 of Schedule 1 as usual and the exclusion, up to $10,200 per individual, is backed out on line 8. On the dotted line next to line 8 taxpayers should show the literal “UCE” letters and the exclusion amount in parentheses.
Unemployment compensation exclusion examples
Example 1: Irena has $15,000 of unemployment income in 2020. Her MAGI is under $150,000.
On Schedule 1 she’ll report $15,000 on line 7, negative $10,200 on line 8, and $4,800 ($15,000 - $10,200) on line 9. The notation “UCE ($10,200)” would also show on the dotted line next to line 8.
Example 2: Joint filers Frank and Ellie both received unemployment income in 2020. Frank received $12,000 and Ellie received $8,000. Their MAGI is under $150,000.
On their Schedule 1 they’ll report $20,000 on line 7, negative $18,200 on line 8, and $1,800 on line 9. The notation “UCE ($18,200)” would also show on the dotted line next to line 8.
Note that the $10,200 is applied separately to each spouse, which prevents Frank from excluding all of his unemployment. Thus, their exclusion is limited to $18,200 ($10,200 for Frank and $8,000 for Ellie).
IRS to adjust most returns for unemployment compensation exclusion; most taxpayers do not need to amend
In news release IR-2021-71 the IRS announced that it will take steps to automatically issue refunds this spring and summer (beginning in May). The announcement applies to taxpayers who filed their returns and included the full amount of unemployment compensation in taxable income before the ARPA was signed into law on March 11, 2021.
Amended returns are generally not needed for unemployment compensation exclusion
For taxpayers who have already filed, the IRS will determine the correct taxable amount of unemployment compensation and the correct tax result. For example, if the change in MAGI results in higher EITC, the recalculation would include the additional EITC amount. Any overpayment will either be refunded or applied to other outstanding taxes owed.
There is no need for taxpayers to file amended federal returns unless the recalculation makes the taxpayer newly eligible for a credit or deduction.
Example 3: George is a single filer with no children. In 2020 he had earned income of $8,000 and unemployment compensation of $10,000. Because of his AGI of $18,000, George was not eligible for EITC for childless taxpayers, which for 2020 is fully phased out for earned income/AGI of $15,820 or more.
The IRS refigures George’s return to remove the $10,000 unemployment compensation and refund any tax paid on it. After the $10,000 unemployment compensation exclusion is applied, George’s earned income/AGI of $8,000 makes him eligible for the maximum EITC of $538. However, since George did not claim the EITC on his original return, the IRS recalculation does not include EITC. He’ll need to file an amended return to claim the credit.
Suppose instead that George received unemployment compensation of only $6,000 so his AGI was $14,000. He claimed EITC of $137 on his original return. In that case, in addition to applying the exclusion, the IRS also recalculates George’s EITC based on the $8,000 earned income/AGI. He does not have to file an amended return.
IRS adjustments for unemployment compensation exclusion to start in May
Starting in May 2021, the IRS will adjust already-filed tax returns in two phases. The first phase will include most taxpayers eligible for the up to $10,200 exclusion. The second phase will include joint filers eligible for the up to $20,400 exclusion and returns with more complex tax situations.
For those who have not yet filed, IRS’s release New Exclusion of up to $10,200 of Unemployment Compensation explains how to determine MAGI for purposes of the exclusion and the exclusion amount to show on line 8 of Form 1040, Schedule 1.
Note: For purposes of the unemployment exclusion, MAGI does not include unemployment compensation itself. For instance, if a taxpayer has unemployment compensation of $10,200 and other income of $139,800, MAGI for the exclusion is $139,800 and the taxpayer is eligible for the exclusion. The taxpayer would use $139,800 to determine most AGI-limited tax items and $150,000 for certain items such as taxable social security benefits. See the updated forms instructions for a full list of items not affected by the exclusion.
More information on IRS adjustments yet to come
While the IRS notice answered many outstanding questions regarding the timing and approach the IRS will use, there are still a few unknowns. For example, it’s not clear yet what types of complex returns will be included in the second phase. We’ll publish updates as we learn more information from the IRS.
The IRS also notes taxpayers may want to review their state tax returns too. Tax professionals should wait for further guidance before filing impacted amended returns at the state or federal level. We're waiting for further guidance from IRS on when taxpayers that are eligible for an additional credit should amend, and we're waiting to hear from states as well.