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Opinion Why millions of unemployed workers may face unexpected tax bills

Outside Internal Revenue Service headquarters in Washington in early January. (Samuel Corum/Bloomberg)
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Michele Evermore is a senior analyst for the National Employment Law Project.

On Jan. 19, Sen. Bernie Sanders (I-Vt.) called for Congress to “make sure that unemployment benefits during this crisis period are not taxable so that workers don’t get hit with a huge tax bill they didn’t expect on April 15.” Last fall, Sen. Richard J. Durbin (D-Ill.), introduced legislation that would have exempted the first $10,200 in unemployment benefits from income tax in 2020.

If you’ve never been unemployed, you may be perplexed: Unemployment benefits are taxed as income? The millions of Americans who were thrown out of work in the past year for the first time may be about to receive a rude lesson in the country’s peculiar approach to misfortune. It’s like throwing a lifeline to a drowning person, then slicing a few strands of the rope before saying, “Good luck!”

Making matters worse for many recipients, especially those in California, there are a couple of wild cards in the mix that could make this April 15 even more miserable than usual for the unemployed.

First, let’s start with the practice of charging income tax to people who have lost their jobs. Taxation of unemployment benefits was gradually phased in during the 1980s to cover all unemployment income by 1987. Why? Because Republicans worried that unemployment payments were too high and would discourage recipients from looking for work. Now most states, in addition to the federal government, raid unemployment benefits for tax revenue.

Unemployment insurance is meant to be a countercyclical stabilizer when the economy falters, providing immediate cash assistance to the people most in need. Without money taken off the top in taxes, unemployment benefits could be an even more powerful tool to keep families and communities afloat. Unemployment benefits are the least sufficient in states with the highest populations of Black, Latino and Indigenous workers, and they are the most critical lifeline to Black and Asian American workers, who are more likely to experience the longest periods of unemployment.

Now for the two anomalous problems that promise to make this tax season particularly onerous for millions of people who lost their jobs in 2020.

The first is a California-only problem: Unemployed workers in the Golden State probably don’t realize that no withholding was taken from some of the benefits they received for pandemic relief.

Full coverage of the coronavirus pandemic

Since 1996, states have been required to offer withholding for regular unemployment benefits — a credit against income, paid directly to the Internal Revenue Service by employers, reducing the tax bills faced by employees at the end of the year. But states were not required to offer that option for all pandemic benefits, and California chose not to do it. The Employment Development Department (EDD) did not withhold taxes for the $600 weekly emergency pandemic addition to benefits for anyone receiving any kind of unemployment check that was paid through the end of July, nor did it withhold taxes on the extra $300 granted by executive memorandum that paid benefits through early September.

In a final, out-of-the-blue insult to Americans across the nation who lost their jobs in 2020, there is an international fraud ring known as Scattered Canary impersonating U.S. workers filing unemployment benefit claims.

This ring has been attacking state unemployment systems since at least May, when the Secret Service issued a warning about “potential losses in the hundreds of millions of dollars.” By now, the ring has likely hit every state system, often in multiple waves, according to authorities.

How much trouble are we talking about? The average weekly benefit in the United States is $306.35. A claimant using 39 weeks of base benefits plus the $300 and $600 add-ons would have had about $2,515 withheld. Many of these unemployed workers in California may well have spent the money they now owe to the IRS.

The fraudsters are likely using personal data exposed through the 2017 Equifax data breach and other security breaches. Some of the impersonated workers will be mystified to receive a government 1099-G income statement for payments they never saw. Others may not receive a 1099-G but will find out after filing their 2020 taxes that the IRS has a form for them on file, as the fraudsters may have changed their mailing address. Many unemployed workers may receive a tax bill and even pay it, not realizing that it isn’t their responsibility.

The main problem with unemployment benefits, though, and the one affecting the greatest number of Americans, is not specific to the past year: the needlessly punitive practice of taxing unemployment benefits as income. The proposals by Sanders and Durbin would be a good start, but this crisis should spark a conversation about the need to end taxation of unemployment benefits entirely.

Meanwhile, as unemployed workers live on poverty-level benefits and may now face tax bills they can’t afford to pay, Paycheck Protection Program loans — the stimulus boost for businesses — are not taxable.

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