How to Recover Income Tax Paid on Unemployment Benefits when You Have to Repay the Benefits

When you receive unemployment benefits you are generally subject to federal income tax on those benefits. But there may be cases in which you have to return unemployment benefits. In that case, you can recover the income tax you paid on the portion of the benefits you had to return.

You may have to pay back unemployment benefits that were overpaid due to an error by you or by the state agency that pays the benefits. According to an article by Alice Gomstyn on the ABC News Money website, the U.S. Department of Labor estimates that over $7.1 billion was overpaid in 2009, with $2.27 billion of that amount due to errors by the state agencies.

You may also have to pay back unemployment benefits if your former employer challenges your claim and the state agency rules in their favor, denying your right to unemployment benefits. This may occur after you have already received unemployment benefit payments.

According to the U.S. Department of Labor, your unemployment benefits may be denied if you voluntarily left your job without what the state law considers to be just cause, or if you lost your job due to misconduct. Your benefits could also be denied if you are not able or willing to work or if you refuse an offer of suitable work.

As indicated by the IRS, if you had to repay unemployment benefits in the same year you received them, you can subtract the amount you repaid from the total amount of benefits you received and report the net amount on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ. On the dotted line next to the amount, you should enter "Repaid" and the amount you repaid. The state agency that pays unemployment benefits will send you a Form 1099-G showing the total unemployment compensation paid to you. You may not receive a revised 1099-G if you had to repay part or all of the benefits.

If you repaid unemployment benefits that you included in your income in a prior year, you can claim the repayment as an itemized deduction on line 23 '" "Other expenses" of Schedule A. But this only helps if you itemize deductions, and this amount would only be deductible to the extent it exceeds 2% of your adjusted gross income.

If the amount you repaid was more than $3,000 you can claim an itemized deduction or a tax credit in the year you made the repayment, whichever results in a lower tax. To determine the credit you would refigure your tax for the earlier year without including in income the amount you repaid. You would compare this amount with the tax shown on the return you filed for the earlier year. The difference is the credit you can claim the year you paid back the unemployment benefits. This credit is claimed on line 72 of Form 1040, which is the line for total payments. Next to line 72 you should enter "I.R.C. 1341". This refers to the Internal Revenue Code that applies to previously reported income that has to be paid back.

Sources:
Alice Gomstyn, "Labor Dept. Estimates $7.1 Billion in Overpayments to Unemployed" '" ABC News Money
Benefit Denials '" United States Department of Labor
Form 1099-G '" Certain Government Payments - IRS
Publication 525 '" Taxable and Nontaxable Income '" IRS
Schedule A '" Itemized Deductions - IRS