The IRS updated the 2020 unemployment compensation exclusion FAQ to allow certain taxpayers to keep an erroneous reduction of their federal taxes when the IRS corrected their 2020 Form 1040 to compute the excludable unemployment compensation following changes made in the American Rescue Plan Act.[1] The issue affects certain married taxpayers filing joint returns in non-community property states who received unemployment compensation in 2020.

Most advisers are aware the IRS faced a number of challenges beginning in 2020 that carried into 2021. The enactment of the American Rescue Plan Act which made certain retroactive changes to the law that applied to 2020 didn’t help, especially not coming just over two months after Congress made a number of late year changes to 2020 tax law at the very end of 2020.

The IRS has now disclosed one particular error the agency made trying to deal with the American Rescue Plan Act’s changes to the taxation of unemployment compensation. The error resulted in the IRS computing an erroneously low total federal tax for certain taxpayers on their 2020 income tax return. The agency has now announced those taxpayers will not be required to amend their 2020 tax return or pay the additional tax that they should have paid.

The IRS added question 10 to Topic G (Receiving a Refund, Letter or Notice) of the FAQ to add a new question and answer. The added question and answer reads:

Q10. I’m married, do not live in a community property state and filed a joint 2020 tax return with my spouse. We received a notice stating the IRS corrected our return to allow the unemployment compensation exclusion, but we believe the exclusion amount is too much. Do we need to file an amended return or pay back all or some of the refund we received? (added January 7, 2022)

A10. The IRS moved quickly to implement the provisions of the American Recovery Plan Act (ARPA) of 2021. ARPA allows eligible taxpayers to exclude up to $10,200 of unemployment compensation on their 2020 income tax return. For married taxpayers, separate exclusions can apply to the unemployment compensation paid to each spouse. In some cases, when Form 1099-G, Certain Government Payments, information was not available, the IRS automatically allowed an exclusion amount of up to $20,400 for married individuals who live in a non-community property state and who filed a joint 2020 tax return when:

· The total unemployment compensation was $10,201 or more;

· The modified adjusted gross income of the taxpayers was less than $150,000; and

· Form 1099-G data was not available at the time when the IRS completed the correction.

If the IRS determined you qualified for the exclusion based on the criteria above and as a result you received a refund, then you are not required to pay back all or part of the refund.

There is no need to contact the IRS or to file an amended return.

If you’re married and live-in community property state, refer to Q4 under Topic A: I'm married and live in a community property state. Am I eligible for the exclusion?[2]

While married taxpayers living in the 9 community property states who received unemployment of over $10,200, filed a joint return and who had modified adjusted gross income of under $150,000 might initially be miffed about how they missed out, they actually didn’t. In community property states, the total unemployment compensation received by both spouses was community income (treated as ½ assigned to each spouse even if all was paid to a single spouse) and, thus, they would have received the same treatment as if they had lived in a non-community property state and were impacted by this glitch. The only difference is that the community property couple’s tax was properly computed in that case.

[1] “IRS updates 2020 unemployment compensation FAQs,” FS-2022-01, January 7, 2022, https://www.irs.gov/pub/newsroom/fs-2022-01.pdf (retrieved January 7, 2022)

[2] “IRS updates 2020 unemployment compensation FAQs,” FS-2022-01, January 7, 2022, https://www.irs.gov/pub/newsroom/fs-2022-01.pdf (retrieved January 7, 2022)