What Was the 2020 Unemployment Compensation Exclusion?

In early 2021, the American Rescue Plan Act introduced a one-time tax adjustment for unemployment benefits received during 2020. This federal law was enacted on March 11, 2021, well after the 2020 tax filing season had commenced, creating a retroactive tax exclusion. This timing presented a challenge for taxpayers who had already submitted their federal income tax returns. This temporary relief measure applied only to the 2020 tax year and is not available for any subsequent years.

Eligibility for the Unemployment Exclusion

To qualify for this tax provision, taxpayers had to meet two criteria. The primary requirement allowed an individual to exclude up to $10,200 of unemployment benefits from their federally reported gross income. This provision applied to each spouse individually, so if both spouses received benefits, they could exclude up to $20,400 on a joint return.

The second condition was an income limitation based on the taxpayer’s 2020 modified adjusted gross income (MAGI). To be eligible, a taxpayer’s MAGI had to be less than $150,000. This income cap was the same for all filing statuses, including single, married filing jointly, and head of household, and it functioned as a strict cutoff. If a taxpayer’s MAGI was $150,000 or more, they were not eligible for any portion of the exclusion. For this purpose, MAGI was calculated as adjusted gross income without factoring in the unemployment benefits themselves.

Impact on 2020 Federal Tax Returns

Because the law passed mid-season, the Internal Revenue Service (IRS) automatically identified and corrected returns for those who had already filed. The agency recalculated the tax liability for eligible individuals, factoring in the new exclusion, and issued refunds or applied the overpayment to other tax debts. This automatic process meant most early filers did not need to take any action to receive their adjustment.

A secondary effect of the exclusion was its impact on a taxpayer’s adjusted gross income (AGI). By lowering AGI, the exclusion could make a taxpayer newly eligible for other income-based tax credits and deductions they did not qualify for on their original return. For example, a lower AGI might have qualified a filer for the Earned Income Tax Credit (EITC), the student loan interest deduction, or other education credits.

While the IRS automatically adjusted the taxable portion of unemployment income, its automated system did not recalculate eligibility for these other credits if the taxpayer had not claimed them initially. This created a situation where some taxpayers were still required to file an amended return to claim the full amount of tax benefits they were entitled to under the new law.

State-Level Tax Treatment

The federal government’s decision to make a portion of 2020 unemployment benefits non-taxable did not mandate that states follow the same approach. The treatment of the unemployment exclusion varied significantly from one state to another, as each has its own tax laws. Because of this, taxpayers could not assume their state tax liability would mirror their federal adjustment.

State responses fell into three categories. Some states chose to fully conform to the federal law, while others offered only a partial exclusion or had pre-existing laws that already exempted unemployment income. A third group of states did not conform at all, meaning all unemployment compensation remained fully taxable at the state level. Individuals needed to consult their specific state’s department of revenue for guidance.

Amended Returns and Verifying Adjustments

For taxpayers uncertain about whether the IRS processed their automatic correction, the first step is to verify their account for the 2020 tax year. This can be done by accessing their personal tax account through the IRS website or by requesting a 2020 tax transcript. These documents provide a detailed record of all transactions on the account, including any adjustments made by the IRS for the unemployment compensation exclusion.

Even if the IRS automatically corrected the unemployment income, some individuals still needed to file a Form 1040-X, Amended U.S. Individual Income Tax Return. This was necessary to claim tax credits or deductions that a taxpayer became newly eligible for after the exclusion lowered their AGI. For instance, if the reduction in income made a filer eligible for the EITC, they would have to file an amended return to claim that credit. The amended return would report the corrected AGI and include the forms or schedules for any new credits being claimed.