Unemployment compensation (UC) benefits have been fully subject to the federal income tax since the passage of the Tax Reform Act of 1986 (P.L. 99-514). Individuals who receive UC benefits during a year may elect to have the federal (and in some cases state) income tax withheld from their benefits. Legislation was introduced in the 108th Congress that would have repealed the taxation of UC benefits, provided a two-year suspension of the taxation of UC benefits, or transferred the proceeds from taxing UC benefits to the Unemployment Trust Fund. This report provides an overview of the taxation of UC benefits and legislation related to taxing UC benefits

Domestic Social Policy Division

Scott, Christine

English

UNT Digital Library

1 In law, this program is called the UC program.  However, it is commonly referred to as the UIprogram, reflecting the social insurance design. For more information regarding  the UC program,see CRS Report 94-417, Unemployment Compensation: A Fact Sheet, by Celinda Franco, andCRS Report 95-742, Unemployment Benefits: Legislative Issues in the 108th Congress, by CelindaFranco.2 While most states tax UC benefits that are subject to federal income taxes, some taxes exemptRailroad unemployment compensation from state income taxes.  Congressional Research Service ˜ The Library of CongressCRS Report for CongressReceived through the CRS WebOrder Code RS21356Updated January 14, 2005Taxation of Unemployment BenefitsChristine ScottSpecialist in Tax EconomicsDomestic Social Policy DivisionSummaryUnemployment compensation (UC) benefits have been fully subject to the federalincome tax since the passage of the Tax Reform Act of 1986 (P.L. 99-514).  Individualswho receive UC benefits during a year may elect to have the federal (and in some casesstate) income tax withheld from their benefits.Legislation was  introduced in the 108th Congress that would have repealed thetaxation of UC benefits, provided a two-year suspension of the taxation of UC benefits,or transferred the proceeds from taxing UC benefits to the Unemployment Trust Fund.This report provides an overview of the taxation of UC benefits and legislationrelated to taxing UC benefits.  This report will be updated as legislative activitywarrants.OverviewUnemployment compensation (UC)1 benefits are fully subject to the federal incometax.  This tax treatment, which has been in place since 1987, puts UC benefits on a parwith wages and other ordinary income with regard to income taxation.In addition to being subject to federal income taxes, UC benefits, as shown in Table1, are taxed by the District of Columbia and 33 of the 40 states with an income tax.2 Most other industrial nations also tax unemployment benefits.CRS-2State UC agencies must give benefits claimants the opportunity to elect withholdingat the time the claimant first files for UC benefits.  Benefits claimants wishing to havefederal income tax withheld from their UC benefits must file form W-4V, VoluntaryWithholding Request.  The current withholding rate for federal income tax is 10% of thegross UC benefits payment.States can also offer UC benefits recipients the option of having state income taxeswithheld from their UC benefits.  In 2004, as shown in Table 1, UC benefits recipientscould have state income tax withheld in 17 of the 34 jurisdictions (states and the Districtof Columbia) that tax UC benefits for tax year 2003.Table 1.  State Personal Income Taxes and State Taxation of UCBenefits in Tax Year 2003; and Withholding on UC Benefits forState Income Taxes in 2004StateState IncomeTax, Tax Year2003UC Benefits Taxed at State Level, Tax Year 2003Withholding on UCBenefits  for State IncomeTax (Current — 2004)Alabama XAlaska  Arkansas XArizona X X XCalifornia XColorado X X XConnecticut X X XDelawareDistrict of Columbia X XFloridaGeorgia X X XHawaii X XIdaho X XIllinois X XIndiana X XIowa X X XKansas X X XKentucky X XLouisiana X XMaine X X XMaryland X X XMassachusetts X X XMichigan X X XMinnesota X X XMississippi X XCRS-3StateState IncomeTax, Tax Year2003UC Benefits Taxed at State Level, Tax Year 2003Withholding on UCBenefits  for State IncomeTax (Current — 2004)Missouri X XMontana XNebraska X XNevadaNew HampshireNew Jersey XNew Mexico X XNew York X XNorth Carolina X X XNorth Dakota X X XOhio X XOklahoma X X XOregon X XPennsylvania XRhode Island X XSouth Carolina X XSouth DakotaTennesseeTexasUtah X X XVermont X X XVirginia XWashingtonWest Virginia X XWisconsin X X XWyomingSource: Table prepared by the Congressional Research Service (CRS) from a survey of state websitesrelated to tax year 2003 personal income tax forms and current (2004) unemployment compensationinformation for claimants.Impact of Taxing UC BenefitsThe following three tables show the latest tax return data related to UC benefits.Table 2 shows the number of returns with UC benefits and the amount of UC benefits fortax years 1998-2002.  The increases for tax years 2001 and 2002 reflect the recentrecession, and the policy responses including the extension of UC benefits and providingbenefits for individuals impacted by the terrorist attacks and the war in Iraq.CRS-43  The latest available public use file of tax returns is for tax year 1999.Table 2.  Returns With UC Benefits and Amount of UC Benefits, Tax Years 1998-2002Year Number of Returns(millions)Amount(millions)1998 7.1  $ 16,777 1999 6.8  $ 17,649 2000 6.5  $ 16,982 2001 8.8 $ 26,891 2002p 10.4 $ 43,412 Source: Table prepared by the Congressional Research Service (CRS) from datacontained in the Internal Revenue Service, Statistics of Income Bulletins, variousyears.  Tax year 2002 is preliminary data.Table 3 shows, for returns with UC benefits in tax year 1999, the ratio of UCbenefits to total Adjusted Gross Income by income (AGI) class.  As shown in Table 3,UC benefits as a share of AGI declines as income (AGI) increases.  Overall UC benefitsare 7.0% of AGI for all returns with UC benefits in tax year 1999.3Table 3.  UC Benefits as a Share of AGI for Returns With Taxable UC Benefits, Tax Year 1999Adjusted Gross Income (AGI) Class UC Benefits as a Share of AGILess than $15,000a 23.0%$15,000 less than $30,000 12.0%$30,000 less than $50,000 7.0%$50,000 less than $100,000 4.0%$100,000 less than $200,000 2.7%$200,000 and over 1.1%Total 7.0%Source: Table prepared by the Congressional Research Service from the Internal Revenue Service 1999Public Use SOI File.a.  Includes returns with a gross deficit.Typically, the loss of a job, even with unemployment benefits, results in a declinein earned income, and often in total income.  For some taxpayers with children, thedecline in earned income may result in an increase in the earned income credit.  For othertaxpayers, the decline in earned income may enable the taxpayer to claim the earnedincome credit.CRS-54  If the thresholds were adjusted for inflation, the comparable 2004 values would be $58,128 and$72,661.5 Joint Committee on Taxation, General Explanation of the Revenue Act of 1978 (H.R. 13511,95th Congress, P.L. 95-600), Mar. 12, 1979, p. 23.6 For example, see Martin Feldstein, “Unemployment Compensation: Adverse Incentives andDistributional Anomalies,” National Tax Journal, June 1974.7  If the thresholds were adjusted for inflation, the comparable 2004 values would be $23,565 and$35,347.8 Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Tax Equityand Fiscal Responsibility Act of 1982 (H.R. 4961, 97th Congress; P.L. 97-248), Dec. 31, 1982,pp. 28-29.9 Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (H.R. 3838,99th Congress; P.L. 99-514), JCS-10-87, May 4, 1987, pp. 29-30.Legislative HistoryBefore 1979, UC benefits were excluded from income subject to the federal incometax.  In the Revenue Act of 1978 (P.L. 95-600), UC benefits were made partially taxablefor benefits received after December 31, 1978.  Benefits were taxable only for tax filerswhose AGI exceeded $20,000 (single filers) or $25,000 (joint filers).4  Taxation wasapplied to the lesser of (1) UC benefits or (2) one-half of AGI (with UC benefitsincluded) in excess of the above-mentioned AGI thresholds.5During the 1970s, some policy studies had shown that the proportion of wagesreplaced by UC benefits on an after-tax basis was large enough to erode seriously aclaimant’s work incentive.6  Taxation of UC benefits served to reduce the degree of after-tax wage replacement and reduce the work disincentive effect.  But, taxation’s effect wasnot universal.  UC benefits of lower income claimants were left untaxed because theirtotal income was under the tax threshold (i.e., their standard deduction and personalexemptions offset their income).In 1982, Congress lowered the AGI thresholds for taxation of UC benefits.  The TaxEquity and Fiscal Responsibility Act of 1982 (P.L. 97-248) reduced those thresholds to$12,000 for single filers, and $18,000 for joint filers.7  A primary motivation of thislegislation was to raise revenue, but it left in place a policy of protecting lower incomeclaimants from taxation of UC benefits.8Congress made UC benefits fully taxable in the Tax Reform Act of 1986 (P.L. 99-514), effective for benefits received after December 31, 1986.  While this action reversedthe original policy of taxing UC benefits only above an AGI threshold, it occurred in thecontext of a law that removed many low-income filers from the tax rolls, lowered themarginal tax rates for the majority of taxpayers, and expanded eligibility for the earnedincome credit.  The rationale for full taxation of UC benefits was to treat UC benefits thesame as wages and to eliminate the work disincentive caused by favorable tax treatmentfor UC benefits relative to wages.9Concern about claimants’ cash flow problems caused by the lack of tax withholdingfrom UC benefits arose during the 1990-1991 recession. P.L. 102-318 required states toCRS-6inform all new claimants of their responsibility to pay income tax on UC benefits and toprovide them with information on how to file estimated quarterly tax payments.  In 1994,P.L. 103-465 required states to withhold federal income tax from UC benefits if aclaimant requests withholding, and permitted states to withhold state and local incometaxes.  P.L. 103-465 set the federal withholding rate at 15% of the gross benefit paymentamount.  The federal withholding rate was changed to 10% by the Economic Growth andTax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16) effective August 7,2001.Legislation in the 108th CongressDuring the 108th Congress, legislation was introduced to repeal the inclusion of UCbenefits for tax purposes, or impose a two-year moratorium on the inclusion of UCbenefits for tax purposes.  Other legislation introduced would have transferred to the stateaccounts in the Unemployment Trust Fund the tax revenues associated with taxing UCbenefits. No action was taken on the legislation introduced in the 108th Congress.

Taxation of Unemployment Benefits

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Federal Publications Key Workplace Documents 
1-14-2005 
Taxation of Unemployment Benefits 
Christine Scott 
Congressional Research Service 
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Taxation of Unemployment Benefits 
Keywords 
Taxation, unemployment, benefit, UC, compensation, federal, income, state 
Disciplines 
Taxation 
This article is available at DigitalCommons@ILR: https://digitalcommons.ilr.cornell.edu/key_workplace/221 
1
 In law, this program is called the UC program.  However, it is commonly referred to as the UI
program, reflecting the social insurance design. For more information regarding  the UC program,
see CRS Report 94-417, Unemployment Compensation: A Fact Sheet, by Celinda Franco, and
CRS Report 95-742, Unemployment Benefits: Legislative Issues in the 108th Congress, by Celinda
Franco.
2
 While most states tax UC benefits that are subject to federal income taxes, some taxes exempt
Railroad unemployment compensation from state income taxes.  
Congressional Research Service ˜ The Library of Congress
CRS Report for Congress
Received through the CRS Web
Order Code RS21356
Updated January 14, 2005
Taxation of Unemployment Benefits
Christine Scott
Specialist in Tax Economics
Domestic Social Policy Division
Summary
Unemployment compensation (UC) benefits have been fully subject to the federal
income tax since the passage of the Tax Reform Act of 1986 (P.L. 99-514).  Individuals
who receive UC benefits during a year may elect to have the federal (and in some cases
state) income tax withheld from their benefits.
Legislation was  introduced in the 108th Congress that would have repealed the
taxation of UC benefits, provided a two-year suspension of the taxation of UC benefits,
or transferred the proceeds from taxing UC benefits to the Unemployment Trust Fund.
This report provides an overview of the taxation of UC benefits and legislation
related to taxing UC benefits.  This report will be updated as legislative activity
warrants.
Overview
Unemployment compensation (UC)1 benefits are fully subject to the federal income
tax.  This tax treatment, which has been in place since 1987, puts UC benefits on a par
with wages and other ordinary income with regard to income taxation.
In addition to being subject to federal income taxes, UC benefits, as shown in Table
1, are taxed by the District of Columbia and 33 of the 40 states with an income tax.2 
Most other industrial nations also tax unemployment benefits.
CRS-2
State UC agencies must give benefits claimants the opportunity to elect withholding
at the time the claimant first files for UC benefits.  Benefits claimants wishing to have
federal income tax withheld from their UC benefits must file form W-4V, Voluntary
Withholding Request.  The current withholding rate for federal income tax is 10% of the
gross UC benefits payment.
States can also offer UC benefits recipients the option of having state income taxes
withheld from their UC benefits.  In 2004, as shown in Table 1, UC benefits recipients
could have state income tax withheld in 17 of the 34 jurisdictions (states and the District
of Columbia) that tax UC benefits for tax year 2003.
Table 1.  State Personal Income Taxes and State Taxation of UC
Benefits in Tax Year 2003; and Withholding on UC Benefits for
State Income Taxes in 2004
State
State Income
Tax, Tax Year
2003
UC Benefits 
Taxed at State Level, 
Tax Year 2003
Withholding on UC
Benefits  for State Income
Tax (Current — 2004)
Alabama X
Alaska  
Arkansas X
Arizona X X X
California X
Colorado X X X
Connecticut X X X
Delaware
District of Columbia X X
Florida
Georgia X X X
Hawaii X X
Idaho X X
Illinois X X
Indiana X X
Iowa X X X
Kansas X X X
Kentucky X X
Louisiana X X
Maine X X X
Maryland X X X
Massachusetts X X X
Michigan X X X
Minnesota X X X
Mississippi X X
CRS-3
State
State Income
Tax, Tax Year
2003
UC Benefits 
Taxed at State Level, 
Tax Year 2003
Withholding on UC
Benefits  for State Income
Tax (Current — 2004)
Missouri X X
Montana X
Nebraska X X
Nevada
New Hampshire
New Jersey X
New Mexico X X
New York X X
North Carolina X X X
North Dakota X X X
Ohio X X
Oklahoma X X X
Oregon X X
Pennsylvania X
Rhode Island X X
South Carolina X X
South Dakota
Tennessee
Texas
Utah X X X
Vermont X X X
Virginia X
Washington
West Virginia X X
Wisconsin X X X
Wyoming
Source: Table prepared by the Congressional Research Service (CRS) from a survey of state websites
related to tax year 2003 personal income tax forms and current (2004) unemployment compensation
information for claimants.
Impact of Taxing UC Benefits
The following three tables show the latest tax return data related to UC benefits.
Table 2 shows the number of returns with UC benefits and the amount of UC benefits for
tax years 1998-2002.  The increases for tax years 2001 and 2002 reflect the recent
recession, and the policy responses including the extension of UC benefits and providing
benefits for individuals impacted by the terrorist attacks and the war in Iraq.
CRS-4
3
  The latest available public use file of tax returns is for tax year 1999.
Table 2.  Returns With UC Benefits and Amount of 
UC Benefits, Tax Years 1998-2002
Year Number of Returns(millions)
Amount
(millions)
1998 7.1  $ 16,777 
1999 6.8  $ 17,649 
2000 6.5  $ 16,982 
2001 8.8 $ 26,891 
2002p 10.4 $ 43,412 
Source: Table prepared by the Congressional Research Service (CRS) from data
contained in the Internal Revenue Service, Statistics of Income Bulletins, various
years.  Tax year 2002 is preliminary data.
Table 3 shows, for returns with UC benefits in tax year 1999, the ratio of UC
benefits to total Adjusted Gross Income by income (AGI) class.  As shown in Table 3,
UC benefits as a share of AGI declines as income (AGI) increases.  Overall UC benefits
are 7.0% of AGI for all returns with UC benefits in tax year 1999.3
Table 3.  UC Benefits as a Share of AGI for Returns 
With Taxable UC Benefits, Tax Year 1999
Adjusted Gross Income (AGI) Class UC Benefits as a Share of AGI
Less than $15,000a 23.0%
$15,000 less than $30,000 12.0%
$30,000 less than $50,000 7.0%
$50,000 less than $100,000 4.0%
$100,000 less than $200,000 2.7%
$200,000 and over 1.1%
Total 7.0%
Source: Table prepared by the Congressional Research Service from the Internal Revenue Service 1999
Public Use SOI File.
a.  Includes returns with a gross deficit.
Typically, the loss of a job, even with unemployment benefits, results in a decline
in earned income, and often in total income.  For some taxpayers with children, the
decline in earned income may result in an increase in the earned income credit.  For other
taxpayers, the decline in earned income may enable the taxpayer to claim the earned
income credit.
CRS-5
4
  If the thresholds were adjusted for inflation, the comparable 2004 values would be $58,128 and
$72,661.
5
 Joint Committee on Taxation, General Explanation of the Revenue Act of 1978 (H.R. 13511,
95th Congress, P.L. 95-600), Mar. 12, 1979, p. 23.
6
 For example, see Martin Feldstein, “Unemployment Compensation: Adverse Incentives and
Distributional Anomalies,” National Tax Journal, June 1974.
7
  If the thresholds were adjusted for inflation, the comparable 2004 values would be $23,565 and
$35,347.
8
 Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Tax Equity
and Fiscal Responsibility Act of 1982 (H.R. 4961, 97th Congress; P.L. 97-248), Dec. 31, 1982,
pp. 28-29.
9
 Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (H.R. 3838,
99th Congress; P.L. 99-514), JCS-10-87, May 4, 1987, pp. 29-30.
Legislative History
Before 1979, UC benefits were excluded from income subject to the federal income
tax.  In the Revenue Act of 1978 (P.L. 95-600), UC benefits were made partially taxable
for benefits received after December 31, 1978.  Benefits were taxable only for tax filers
whose AGI exceeded $20,000 (single filers) or $25,000 (joint filers).4  Taxation was
applied to the lesser of (1) UC benefits or (2) one-half of AGI (with UC benefits
included) in excess of the above-mentioned AGI thresholds.5
During the 1970s, some policy studies had shown that the proportion of wages
replaced by UC benefits on an after-tax basis was large enough to erode seriously a
claimant’s work incentive.6  Taxation of UC benefits served to reduce the degree of after-
tax wage replacement and reduce the work disincentive effect.  But, taxation’s effect was
not universal.  UC benefits of lower income claimants were left untaxed because their
total income was under the tax threshold (i.e., their standard deduction and personal
exemptions offset their income).
In 1982, Congress lowered the AGI thresholds for taxation of UC benefits.  The Tax
Equity and Fiscal Responsibility Act of 1982 (P.L. 97-248) reduced those thresholds to
$12,000 for single filers, and $18,000 for joint filers.7  A primary motivation of this
legislation was to raise revenue, but it left in place a policy of protecting lower income
claimants from taxation of UC benefits.8
Congress made UC benefits fully taxable in the Tax Reform Act of 1986 (P.L. 99-
514), effective for benefits received after December 31, 1986.  While this action reversed
the original policy of taxing UC benefits only above an AGI threshold, it occurred in the
context of a law that removed many low-income filers from the tax rolls, lowered the
marginal tax rates for the majority of taxpayers, and expanded eligibility for the earned
income credit.  The rationale for full taxation of UC benefits was to treat UC benefits the
same as wages and to eliminate the work disincentive caused by favorable tax treatment
for UC benefits relative to wages.9
Concern about claimants’ cash flow problems caused by the lack of tax withholding
from UC benefits arose during the 1990-1991 recession. P.L. 102-318 required states to
CRS-6
inform all new claimants of their responsibility to pay income tax on UC benefits and to
provide them with information on how to file estimated quarterly tax payments.  In 1994,
P.L. 103-465 required states to withhold federal income tax from UC benefits if a
claimant requests withholding, and permitted states to withhold state and local income
taxes.  P.L. 103-465 set the federal withholding rate at 15% of the gross benefit payment
amount.  The federal withholding rate was changed to 10% by the Economic Growth and
Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16) effective August 7,
2001.
Legislation in the 108th Congress
During the 108th Congress, legislation was introduced to repeal the inclusion of UC
benefits for tax purposes, or impose a two-year moratorium on the inclusion of UC
benefits for tax purposes.  Other legislation introduced would have transferred to the state
accounts in the Unemployment Trust Fund the tax revenues associated with taxing UC
benefits. No action was taken on the legislation introduced in the 108th Congress.


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