Up to 10 million taxpayers could get an additional tax refund for unemployment

The Internal Revenue Service is reviewing the tax returns of 10 million people and will begin issuing additional refunds this week to those who paid too much in taxes for their 2020 unemployment benefits.

"The IRS identified over 10 million taxpayers who filed their tax returns prior to the American Rescue Plan of 2021 becoming law in March and is reviewing those tax returns to determine the correct taxable amount of unemployment compensation and tax," the agency said in a statement on Friday. "This could result in a refund, a reduced balance due or no change to tax (no refund due nor amount owed)."

Under the $1.9 trillion American Rescue Plan, the first $10,200 in unemployment benefits aren't taxed for eligible filers. Because the legislation was signed into law halfway through the tax season, it was unclear what eligible taxpayers should do if they filed their federal return already. The IRS previously said that jobless workers who already filed their taxes won't need to amend their returns.

Filers whose tax returns have been processed will receive two tax refunds: the first reflects how they filed and the second refund will reflect any tax break they get on their unemployment benefits, Commissioner Charles Rettig said in March. 

The IRS will issue the refunds by direct deposit for taxpayers with valid banking information on their 2020 return. They agency will send a paper check if that information is not available.

The refunds will be subject to normal offset rules including past-due federal tax, state income tax, state unemployment compensation debts among others. If the refund is used to pay unpaid debt, the IRS will send a separate notice.

Read more: Top 10 tax mistakes — and how to avoid them

The first phase of the adjustment is made for single filers with simpler tax returns which, for example, didn't claim dependents or any refundable tax credits. The next phase will review more complex returns which may take "through the end of summer" to correct, the agency said.

Both regular unemployment benefits and the jobless benefits provided by the stimulus legislation are subject to income tax. But the newly added tax exemption is for the first $10,200 of unemployment benefits; any benefits above that threshold are taxable. The break applies to the 2020 tax year and for households making up to $150,000.

The break would increase a taxpayer's refund by about $1,000 or reduce their tax liability by the same amount, according to previous estimates from Andrew Stettner, an unemployment insurance expert and senior fellow at the Century Foundation.

Denitsa is a writer for Yahoo Finance and Cashay, a new personal finance website. Follow her on Twitter @denitsa_tsekova

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