Tara’s Tax Tips: IRS Guidance for Unemployment Compensation Exclusion

I’m Tara Fisher, Becker’s resident tax expert. The IRS recently distributed guidance on ARPA in relation to unemployment compensation exclusion. I’ll break down how this affects you as a taxpayer, whether you have already filed a return or not, and walk you through the new Unemployment Compensation Exclusion Worksheet. Let’s get started!

Under normal circumstances, unemployment compensation is included in a taxpayer’s total income. However, the American Rescue Plan Act of 2021 (ARPA) allows the first $10,200 of unemployment compensation to be excluded from a taxpayer’s 2020 income, if their 2020 modified adjusted gross income is less than $150,000.

For taxpayers who file a joint return, each spouse receiving unemployment compensation receives a $10,200 exclusion. Amounts over $10,200 for each individual are taxable.

Taxpayers who have already filed a return

ARPA was signed into law in early March, after many taxpayers already filed their individual income tax returns, so this creates an issue of whether or not the taxpayer should file an amended return to account for the new unemployment compensation exclusion.

The IRS has provided guidance on their website encouraging taxpayers not to file amended returns for tax advantages of the exclusion. The guidance states that “the IRS will refigure your taxes using the unemployment compensation exclusion amount and adjust your account accordingly.” Any refund amount will be sent directly to the taxpayer.

Taxpayers who have not yet filed a return

For those of you who have not yet filed a return, the IRS guidance clarifies that the IRS unemployment exclusion should be reported separately from the unemployment compensation.

The IRS directs taxpayers to report the exclusion as a deduction on Form 1040, Schedule 1, Part 1, line 8, titled “Other Income.”

Taxpayers who received unemployment compensation in 2020 should receive a Form 1099-G showing the total unemployment compensation paid for the year. This amount is reported on Form 1040, Schedule 1, Part 1, line 7 (immediately above line 8 where the exclusion is being deducted.)

Figure 1: Form 1040, Schedule 1, Part 1

All unemployment compensation received should be reported on Form 1040, Schedule 1, Part 1, line 7. Some states issue separate Forms 1099-G for unemployment compensation received from the state, and the additional $600 per week from the federal unemployment compensation coronavirus relief, so these amounts should be added together.

The IRS guidance states that the total amount of unemployment compensation reported on line 7 should be used when figuring out the following deductions or exclusions from the following types of income:

• Taxable social security benefits (Instructions for Form 1040 or 1040-SR, Social Security Benefits Worksheet)
• IRA deduction (Instructions for Form 1040 or 1040-SR, IRA Deduction Worksheet)
• Student loan interest deduction (Instructions for Form 1040 or 1040-SR, Student Loan Interest Deduction Worksheet)
• Nontaxable amount of Olympic or Paralympic medals and USOC prize money (Instructions for Form 1040 or 1040-SR, Schedule 1, line 8)
• The exclusion of interest from Series EE and I U.S. Savings Bonds issued after 1989 (Form 8815)
• The exclusion of employer-provided adoption benefits (Form 8839)
• Tuition and fees deduction (Form 8917)
• The deduction of up to $25,000 for active participation in a passive rental real estate activity (Form 8582)

Taxpayers who made contributions to a governmental unemployment compensation program or to a governmental paid family leave can reduce the amount reported on line 7 by those contributions, as long as they aren’t itemizing deductions. Along the same lines, if a taxpayer received an overpayment of unemployment compensation in 2020 and repaid it during the year, that amount should be subtracted from the total and listed next to the word “Repaid” on the dotted line next to line 7.

The IRS created a new unemployment compensation worksheet, known as the Unemployment Compensation Exclusion Worksheet, to assist taxpayers in computing their modified gross income and the amount of the exclusion. Follow the below steps to complete Schedule 1, Line 8, from the IRS’ official website.

Unemployment Compensation Exclusion Worksheet – Schedule 1, Line 8

1. If you are filing Form 1040 or 1040-SR, enter the total of lines 1 through 7 of Form 1040 or 1040-SR. If you are filing Form 1040-NR, enter the total of lines 1a, 1b, and lines 2 through 7.
    
2. Enter the amount from Schedule 1, lines 1 through 6. Don't include any amount of unemployment compensation from Schedule 1, line 7 on this line.
    
3. Use the line 8 instructions to determine the amount to include on Schedule 1, line 8, and enter here. Do not reduce this amount by the amount of unemployment compensation you may be able to exclude.
    
4. Add lines 1, 2, and 3.
    
5. If you are filing Form 1040 or 1040-SR, enter the amount from line 10c. If you are filing Form 1040-NR, enter the amount from line 10d.
    
6. Subtract line 5 from line 4. This is your modified adjusted gross income.
    
7. Is the amount on line 6 $150,000 or more? 

a. [ ] Yes. Stop You can't exclude any of your employment compensation
b. [ ] No. Go to line 8

8. Enter the amount of unemployment compensation paid to you in 2020. Don't enter more than $10,200.
    
9. If married filing jointly, enter the amount of unemployment compensation paid to your spouse in 2020. Don't enter more than $10,200. If you are filing Form 1040-NR, enter -0- .
    
10. Add lines 8 and 9 and enter the amount here. This is the amount of unemployment compensation excluded from your income.
     
11. Subtract line 10 from line 3 and enter the amount on Schedule 1, line 8. If the result is less than zero, enter it in parentheses. On the dotted line next to Schedule 1, line 8, enter "UCE" and show the amount of unemployment compensation exclusion in parentheses on the dotted line. Complete the rest of Schedule 1 and Form 1040, 1040-SR, or 1040-NR.

Keeping on top of IRS updates will help ensure that you prepare your and your clients’ taxes in an accurate manner and (hopefully) maximize your refund.

For more background on what ARPA entails, read John Stevko’s recap of ARPA tax provisions.

Keep visiting the Becker blog for the latest tax updates that you need to know.

Tara Fisher has been practicing tax for over 20 years. Her professional background includes working for the U.S. Congress Joint Committee on Taxation, the national tax practice of PricewaterhouseCoopers, the University of Pittsburgh, and American University in Washington D.C. She is a licensed CPA and holds both an undergraduate and graduate degree in accounting from the University of Virginia.

The unemployment compensation exclusion content contained in this article is for informational purposes only and is not tax advice. You should consult a tax advisor for advice applicable to your situation.