Tax Insights

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Community property and tax exempt unemployment compensation

Becoming suddenly unemployed was an unfortunate first-time experience for many during the COVID pandemic. While the worst of it seems to be behind us, at least in the United States, there are many ongoing reasons for losing one’s employment. Preserving your income and assets during periods of unemployment is important and that includes doing what you can to keep your taxes as low as possible. Supplementing lost income with unemployment compensation is one tool.

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Some first-time unemployment filers had the unpleasant surprise of finding out their unemployment compensation was considered taxable income. But during the pandemic, the U.S. government via the IRS provided some relief by letting taxpayers exclude up to $10,200 of unemployment compensation if your modified adjusted gross income (AGI) is less than $150,000 no matter your filing status. Married filing joint, single, married filing separate, etc., it didn’t matter. This caveat, a bit unusual, left taxpayers and tax practitioners in community property states with an important question. Can a married couple use that caveat to basically double their $10,200 unemployment income exclusion by filing separate? It took a while for IRS to answer this question after these rules came out, but in a word, YES.

While being mindful of how community property income is reported and taxed by married couples filing separately in a community property state, which is a whole other topic and with its own complexities, if each spouse can report modified AGI of less than $150,000, then each spouse can exclude up to $10,200 of the unemployment income they are required to report (split up as appropriate) on their separate tax return. Even still, that doesn’t mean it’s always going to be advantageous in the end to file separately as it also depends on other tax aspects in your individual situation. So it’s important to work through that as well and get the help of a CPA if needed.

If you have any questions, please contact your Henry+Horne advisor. For more information and resources on COVID-19, see our coronavirus page.

Dale Jensen, CPA