Good news. One of the provisions of the American Recovery and Reinvestment Act is a tax exemption for unemployment benefits. Under the legislation passed earlier this year, the first $2,400 of unemployment benefits will be tax free. The exemption only applies to unemployment compensation received in 2009, and any benefits beyond the $2,400 threshold (roughly 8 weeks of benefits, depending on your state) will still be taxed.
From a historical perspective, unemployment benefits were not taxed until 1979. The viewpoint of lawmakers in Washington, was that people receiving unemployment benefits would be less inclined to seek a new job if benefits were not taxed.
The IRS website has more detailed information about tax on unemployment benefits. The most important thing to know is that you can choose to have tax withheld from your unemployment check by filling out Form W-4V (“Voluntary Withholding Request”). By completing this form, you will have 10% of your unemployment compensation withheld each period.
If you already have tax withheld from your unemployment check for 2009, you will likely receive a pleasant surprise in the form of a refund when it comes time for taxes in April 2010 because the new $2,400 exemption.
In March, the House passed a $9 billion bill to prevent benefit loss. The Senate rushed to pass the House version before the congressional recess started on March 26, but faced opposition from Sen. Tom Coburn (R-Okla.), who demanded that Democrats find a way to pay for the extension. Senate majority and minority leaders Harry Reid (D-Nev.) and Mitch McConnell (R-Ky.) started negotiations on the issue, but failed to reach a compromise before recess.