This tax pitfall could affect millions due to Covid. Here's what you need to know

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The 2020 tax season is officially underway, and the millions of Americans who collected unemployment benefits last year due to the coronavirus pandemic may be in for a surprise.

That unemployment income is taxable, and if you didn’t have money set aside or withheld for those taxes, it could reduce your refund or even lead to a bill.

This might be particularly unexpected for independent contractors and self-employed people who normally aren’t eligible for state benefits but may have received Pandemic Unemployment Assistance through the CARES Act.

“There are going to be a lot of people this year that have unemployment insurance and they do not normally receive unemployment insurance benefits,” said Elaine Maag, a principal research associate at the Urban-Brookings Tax Policy Center. “So it will be something new that they have to pay attention to.”

Differences in state and federal treatment

Uncle Sam isn’t the only entity seeking a slice of your unemployment income. Most states will tax these benefits, too.

A handful of states — Alabama, California, Montana, New Jersey, Pennsylvania and Virginia — don’t tax these payments. Indiana and Wisconsin offer a partial exclusion of unemployment income, according to Andy Phillips, director at the Tax Institute at H&R Block.

“Some states have withholding, and others require it in order to alleviate surprises when tax time comes around,” said Jared Walczak, vice president of state projects at the Tax Foundation.

Though it’s too late to head off the taxes you might owe for 2020, individuals who wrap up their returns early can at least plan to pay the amount owed by April 15 — the due date for tax returns and liabilities owed.

“You don’t have to make a payment until April 15, but it’s better to know in late January or early February that you have to come up with the dollar amount by then,” said Phillips at the Tax Institute at H&R Block.

Unemployment and tax credits

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