Losing your job can be psychologically and emotionally draining, as well as can suck the life out of your bank account. Unemployment insurance is typically a few hundred dollars a week, which is a fraction of what you used to make, and equates to a salary considered under the poverty line in the United States.
Given this, you would think that the government would not make you pay income tax on that money as well. However, you would be wrong; you do need to pay taxes on unemployment income. Well, wrong and right, depending on what year you were unemployed.
Unemployment Taxes: Pay Now or Pay Later
During my unemployment , I had failed to fill out a W-4V form  indicating that I wanted income taxes withheld from my unemployment benefits. I reasoned that come April I would be making much more money and could afford to pay the tax bill at the end of the year; besides, I could use all the money I could get at the time to cover things like the rent, food, student loan payments, and gas bills that didn’t cease just because my job did. Because of my choice I took a tax jab in April 2007 to the tune of $450 which doesn’t sound like a lot, but was something I had failed to plan for.
When you file for unemployment , I would recommend choosing to withhold taxes on your unemployment compensation as you receive it, which means the government will automatically take out a flat 10% no matter how much your paycheck is.
Some states exempt unemployment compensation from state income tax (or are states with no income tax ), but many states, such as Massachusetts, Wisconsin , and New York, take their tax share of your unemployment as well at around 5%. Check with your state’s Department of Revenue for more specific information.
Those Who Don’t Need to Pay Unemployment Taxes
During 2009, with the unemployment rate hovering around 10%, the government took action to make the first $2400 of your unemployment compensation you received in 2009 excluded from taxation  (if you are married and both spouses were unemployed in 2009, each spouse may exclude $2400 from taxation, totaling $4800).
Note, this was only for the 2009 tax year. If you were unemployed in 2008, or are unemployed in 2010 and beyond, you must still pay income tax on your earnings. Also, even if you are exempt from the federal income tax in 2009, be aware that your 2009 earnings may still be liable for state income tax.
Update: The $2400 exclusion expired in 2009, and was not included in the Obama Tax Cuts . Therefore, you cannot claim the exclusion on your 2010 or 2011 taxes. However, the IRS is now waiving failure to pay penalties for taxes due in 2012 for unemployed taxpayers. For more information see: Unemployed Tax Relief .
To determine if you’ll need to pay taxes on other income you make during the year, you can see the guidelines for minimum income to file taxes .