Congress Is Poised to Upend Tax Season With New Break for Unemployment Benefits

WASHINGTON—Congress is about to change a piece of the tax code affecting the returns being filed by as many as 40 million Americans—a month after the tax-filing season started. The move, approved by the Senate on Saturday and headed for House passage on Tuesday as part of the coronavirus-relief bill, would exempt the first $10,200 of 2020 unemployment benefits from income for households that made under $150,000. That could save households about $25 billion, but implementing the change would be a challenge for the already-burdened Internal Revenue Service, and it could lead to unusual disruptions.

As of late February, the IRS had already received more than 45 million tax returns, some of which will now likely have to be amended. And the IRS will need to reprogram its computers to include the new, retroactive change as people file returns to take advantage of it. That is happening during an already messy tax season complicated by the coronavirus pandemic, remote work and a pile of other tax-law changes.

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Unemployment insurance has generally been considered taxable income for several decades, because it is seen as a substitute for earned income. But state rules for withholding from unemployment benefits vary, and advocates were warning that millions of people would face surprise tax bills.

Some Democrats, including Sen. Richard Durbin of Illinois and Rep. Cindy Axne of Iowa, had been pushing for the tax exemption, but party leaders left it out of the first versions of the relief bill. Senators added the proposal late last week as part of an agreement reached to secure the vote of Sen. Joe Manchin (D., W.Va.). Someone in the 12% tax bracket could save more than $1,200. Those in higher brackets could save more, while those without income tax liability would get little if any benefit.

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States will need to adjust their own computer systems, alert taxpayers and prepare to accept amended returns, said Verenda Smith, deputy director of the Federation of Tax Administrators, an association of state tax agencies. But states don’t want an extended deadline either, because that brings its own costs in staffing and delayed revenue.

https://www.wsj.com/articles/congress-is-poised-to-upend-tax-season-with-new-break-for-unemployment-benefits-11615228351 (subscription)