The Senate version of the American Rescue Plan of 2021 added a special rule that applies to unemployment compensation for taxable years beginning in 2020.  The taxpayer may exclude up to $10,200 of unemployment compensation from income if the adjusted gross income of the taxpayer (as computed under the rules for this provision) is less than $150,000.  If a joint return is filed, then each spouse can exclude up to $10,200 of their own unemployment compensation—but note that the adjusted gross income cut-off does not go up for the married couple.[1]

For purposes of determining if a taxpayer has adjusted gross income in excess of the $150,000 limit, adjusted gross income is computed by:

• Not taking into account any exclusion of unemployment compensation under this provision and

• After applying the following sections of the IRC (remembering that we are assuming initially the unemployment compensation is taxable):

  • Calculation of taxable social security benefits under IRC §86;

  • Exclusion from income for certain US Savings Bond interest used to pay educational expenses under IRC §135;

  • Exclusion from income of employer adoption assistance under IRC §137;

  • Deduction for a contribution to a traditional IRA under IRC §219;

  • Deduction for interest on a qualified education loan under IRC §221;

  • Deduction for qualified tuition and related expenses under IRC §222; and

  • Passive loss deductions (in particular the deduction for active rental real estate losses) under §469.[2]

The law also makes conforming amendments to those provisions as well as IRC §74(d)(2)(B).[3]

Note that this is a cliff limitation. At $149,999 of modified adjusted gross income, a full $20,400 exclusion would be available to the taxpayer, but if one additional dollar of income is added the full $20,400 of unemployment compensation becomes taxable.

Revised IRC §85(c) would read in full as follows after the amendment:

(c) Special Rule for 2020.--

(1) In general.--In the case of any taxable year  beginning in 2020, if the adjusted gross income of the  taxpayer for such taxable year is less than $150,000, the  gross income of such taxpayer shall not include so much of  the unemployment compensation received by such taxpayer (or,  in the case of a joint return, received by each spouse) as  does not exceed $10,200.

(2) Application.--For purposes of paragraph (1), the adjusted gross income of the taxpayer shall be determined--

(A) after application of sections 86, 135, 137, 219, 221, 222, and 469, and

(B) without regard to this section.[4]

[1] IRC §85(c)(1) as it would be revised by the Senate passed version of the American Rescue Plan of 2021

[2] IRC §85(c)(2) as it would be revised by the Senate passed version of the American Rescue Plan of 2021

[3] Senate passed version of the American Rescue Plan of 2021 §9042(b)

[4] Senate passed version of the American Rescue Plan of 2021 §9042(a).  The text of amendment can be found at TEXT OF AMENDMENTS; Congressional Record Vol. 167, No. 42, (https://www.congress.gov/congressional-record/2021/03/05/senate-section/article/S1291-1)at Page S2390.