Calculating Unemployment Compensation to Exclude from Income

Hello again, everybody. This is Tom O’Saben from the University of Illinois Tax School coming to you with this week’s blog. As I’ve told you throughout this tax season, the changes from the IRS are coming hot and heavy. So I know last week I concentrated on some of the different provisions of the American Rescue Plan. Today, I’m going to concentrate specifically on new guidance the IRS just gave us on how to calculate modified adjusted gross income and what to do with that $10,200 of potentially excludable unemployment compensation. So again, my name is Tom O’Saben, I’m the Assistant Director of Professional Education and Outreach for the Tax School, I’m a fall Tax School instructor, and author and reviewer of the University of Illinois Tax Workbook. I’m heavily involved in the webinars that we do, both in the fall and throughout the year, and these blogs that we do on a weekly basis. Also, I’m a practitioner with now 31 years of experience. So again, it’s an unprecedented year and I certainly feel what you’re going through.So again, we’re going to talk today about the update the guidance we received from the IRS on March the 24th, about calculating unemployment compensation, how much we can exclude from income, and how to get there. So to give you a little bit of background, the guidance came out on March 24th of 2021. I’ve given you a link here, you probably will need to copy and paste this into your Google search bar in order to get directly to the information. What we have gotten from IRS is different from what the interpreted just one week ago. The bottom line of all of this is you get to determine the modified adjusted gross income of the taxpayer, without the inclusion of any unemployment compensation they received. This is a really, really big deal folks because you might remember from the previous blogs that we’ve done, and I would encourage you to go and listen to those. Just go to the University of Illinois Tax School, Google it, click on read the weekly blog or listen to the weekly blog as this would entail and listen to the rules that are involved.

The American Rescue Plan says you can exclude up to $10,200 of unemployment compensation or twice that if you’re a married couple filing jointly, as long as your modified adjusted gross income is less than $150,000. So that being said, my first question that I had said in previous blogs was, does this mean $150,000 is the same as that $150,000 exclusion is the same as for married filing jointly? As it is for single? As it is for head of household? As it is for married filing separately? The IRS interpretation is yes. But initially, what the IRS had been saying was the $150,000 needed to include all of the unemployment compensation. The guidance from March 24th basically says determine that modified adjusted gross income without the unemployment included. So what I’ve done then is I’ve gone ahead and copied and pasted for you from the instructions at irs.gov that I just gave you the link on on the previous slide. So it says first of all, on Schedule 1, on line 7, include all of the unemployment compensation, all for one party or all for both parties if they’re married filing jointly.

Okay, now, here come the instructions for line 8. So they tell us, first of all, I’m gonna go through these instructions and I’m going to give you a couple of examples. Okay, on line 8, if you’re filing a 1040, for example, add the total of lines 1 through 7 of the Form 1040. Okay, then go to the Schedule 1 and enter the amounts for lines 1 through 6, don’t get into the unemployment yet at this point. Then we have to look at use the line 8 instructions to determine the amounts to include on Schedule 1, line 8 that aren’t part of the unemployment. You know, it could be other income, I don’t know jury duty, or some other miscellaneous income that we used to just schlep on to that miscellaneous item inclusion line and take a look there. Then it says add lines 1, 2, and 3. It says if you’re filing Form 1040, enter the amount from line 10c, from the 1040 line 10c. You know what those are ladies and gentlemen? I’ll show those to you again on the form in a little bit, those are our adjustments to income. If you’re close on this scenario I’m going to get into, then maybe this is the planning part. What would we have for adjustments to income? Things like alimony paid, IRA deductible contributions, HSA contributions, the tuition and fees deduction, all of those types of items. Once you’ve done that, this determines your modified adjusted gross income. Notice we haven’t said anything yet about unemployment compensation. Is that amount on line 6 $150,000 or more? If it’s yes, you’re done. So as I describe to you what I took out of the American Rescue Plan, when I first started talking about it several weeks ago, I said it appears to be a cliff, not a phase out $150,000 and $1, you’re done. But the difference we have out of the guidance from IRS right now, is that it’s the determination before we look at the unemployment compensation. So if the answer is we’re not at $150,000 or more, then go ahead to line 8. So I guess it has to be under $150,000. So $150,00 you’re dead, $149,999 you’re okay.

All right, moving on. Now it says in this worksheet, this is not on a form yet, enter the amount of unemployment compensation paid you in 2020, don’t enter more than $10,200 because what we’re determining now is the amount to exclude. This is not and I’ll explain this in a minute, just stay with me, this is your instructions for line 8. If married filing jointly, enter the amount of unemployment compensation they received, but not more than $10,200. So I used an example in last week’s blog of Joe taxpayer, where I said he had $10,200 and then I said let’s make him married and let’s make him married to Betsy. Okay, so in that case on this worksheet and Betsy received $2,000 of unemployment compensation. On this worksheet we’ve put in $10,200 for Joe, $2,000 for Betsy. Again, we’re not talking about the total amount of unemployment compensation, we’re talking about what to exclude. Add those up, add lines 8 and 9, enter the amount here, the worksheet isn’t yet out with lines on it. This is the amount of unemployment compensation that we can exclude. Then it says subtract this total from line 3, which would be other items that we’ve thrown in miscellaneous pieces of other income, and enter it on Schedule 1, line 8. If it’s less than 0, put it in parenthesis. This is where we’re going to make the subtraction, we’re going to put it in brackets. On the dotted line I mentioned last week, it’s this time of year, I typed it wrong and stated it wrong. You put in the acronym UCE, that means unemployment compensation excludable and show the amount of unemployment compensation excluded on the dotted line, and then we complete the rest of the Schedule. So the big, big takeaway from this, is that that modified adjusted gross income is determined before we consider the unemployment compensation.

So let’s take a look now at a couple of examples I’ve got. So I carved out part of a tax return, you see here that there’s wages of $51,000, there’s some interest, there’s some qualified dividends. It just so happened that in this case, the client also had a pension that they rolled over and we also had some capital gains. So you can certainly see out of this scenario, this is by the way, a married couple filing jointly and both of my examples will be a married couple filing jointly. I only carved out a little bit of the tax return to protect the innocent, let’s say it that way. So it looks like this one is going to be a slam dunk, doesn’t it? And I’m not setting you up for anything. I’m just going ahead, now this is the Schedule 1, and it’s told us do we have anything in part 1? Things like taxable refunds, alimony received, business income that might be coming from a Schedule C, other gains and losses, like ordinary gains of a 4797. If we have rental property or farm income, all of those items would come into play as additional income items on that Schedule 1. Then it says here for example, I’m showing the conclusion, line 7, we put all of the unemployment. For example, in this case, only one of the parties received unemployment, actually, she received a lot of unemployment $27,107. So when we did all that calculation, we concluded a number without the benefit of the unemployment to be less than $150,000. So we were able to exclude a full $10,200, this was the only thing going on the Schedule 1, so $16,907 becomes the amount that ends up on the front of the 1040. And I carved that out here for you $16,907 and then their total income ended up being $71,345. So again, way below the $150,000 per the American Rescue Plan, but we saw what we needed to do.

So let’s look at another quick scenario. Here’s a couple where their income without unemployment is $151,546, again, this is a married couple filing a joint tax return. We’re gonna see a problem here, aren’t we? In additional income, again, there wasn’t any. We didn’t have any taxable refunds, no alimony, no Schedule C income, no other gains, no rental, no farm. So we look at the unemployment that was received, it was $5,520. Notice on line 8 there’s nothing here because when you run through those instructions you’ll get to the part where it says, is this amount at $150,000 or more? And the answer is yes, stop. Nothing is excludable. So in this case, the whole $5,520 has to be included in income. And right here on the 1040, you see it, we go from $151,546, up to $157,066. Even though we’ve got adjustments to income that we would do on the Schedule 8 instructions, we end up being exactly at $157,000. And ladies and gentlemen, we don’t get to exclude anything.

So you would think here from a standpoint of planning, and by the way, I’ll tell you this example is real close to home. Not me personally, but a member of my family, let’s say it that way, who is married. And it absolutely made me sick that $15,046 caused several things. One, it caused all of the unemployment to be taxable, nothing excludable. It is also going to impact the $1,400 stimulus payments when there’s a reconciliation on that, either this summer, or when the 2021 return is filed. You know, if you think about it, that $1,400 one has such a quicker phase out that you basically lose about 10% per $1,000. Well, when we were at $151,546 I said, well, I think you’re going to lose about 15% of those $1,400 stimulus checks. In this case, this couple would be eligible receive three of them, the two of them and their child, who also happens to be my grandson. However, well instead we’re going to be at $157,000. So what we’re going to lose 70% of those $1,400 payments when reality comes around and so it has a dramatic impact. I find this very, very interesting when you look at the fact that the worksheet for line 8 allows us to consider adjustments to income. And I tried that with this scenario, would it help us to fund an IRA? Well, we can fund an IRA, we’re not precluded from doing that, nothing is deductible. Both parties have a pension plan at work, they do not have an HSA, we do not have a circumstance of having a tuition and fees deduction, there was nothing I could find, to go ahead and reduce this modified adjusted gross income before the unemployment compensation to get it below $150,000. I’ll be honest with you, I mentioned this in a Facebook posting, I didn’t think about how to calculate this, I just went ahead and did it on my own. I forgot to consider their modified adjusted gross income and we filed this return with the $55,020 excluded. Well because of that, the taxpayers owe back $17,075 on federal and $300 to their state. Why? Because one of the things they didn’t get last year, well, a couple things. One, their actual 2020 income is lower than it was in 2019, which was the base year used for this. And secondly, they had my little grandson during the year so we didn’t have the economic impact payments for my grandson. So those also were adjusted more than when I first filed the return. So, I tell you sometimes making a mistake or having some failure in life is the best teacher. It’s not easy to tell your child that, oh by the way, your returns already been filed, already been accepted, but when you get your money we have to amend and you got to give back $2,000, but anyway, live and learn. It’s a brand new world and I feel what you’re going through the original guidance from IRS included the unemployment in that $150,000 test, now it doesn’t. That’s the main thing to get out of it and even in this situation, where we were just a skosh over $150,000 they don’t get to exclude any of it.

So again, we’re trying to keep you updated as quickly as we get information. I know you’re still waiting to hear about the exclusion of those advanced premium tax credits, we yet to have guidance from IRS. We’ll keep you posted and we’ll be there for you. For all of us here at the University of Illinois Tax School, this is Tom O’Saben saying we’ll say goodbye for just a while.
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