Taxation of 2020 Unemployment Benefits at Federal and State Levels

As you may know, prior to 2020, all unemployment benefits were taxable income for purposes of federal income tax. Then, in 2021, a portion of 2020 unemployment benefits was made exempt from federal tax by retroactive legislation. However, each state had to decide whether or not to align with the federal statute and exempt the unemployment benefits from state income tax.

For example, Indiana is a state that begins its individual tax computations with a figure from the federal income tax return, Adjusted Gross Income (AGI). Indiana decided not to treat unemployment as nontaxable in the same way as the IRS. Since the unemployment is not included in the federal AGI, it must be added-back in the state income tax return.

It is common for states to require multiple adjustments (add-backs and deductions) to federal AGI, but this example is one that has affected more individuals and families than most in prior years.

Additionally, Indiana made this decision after many individuals had filed their 2020 tax returns. So, some Indiana taxpayers may expect the state to adjust their income tax returns to comply with this late legislative change.