The IRS has started reviewing 2020 income tax returns of eligible individuals who reported unemployment compensation, but did not claim the unemployment compensation exclusion provided by the American Rescue Plan Act (ARPA or ARP Act, PL 117-2). Individuals who paid taxes on unemployment compensation that should have been excluded from their income will begin receiving
refunds the week of May 17.

Background. Generally, an individual’s gross income includes unemployment compensation. ( Code Sec. 85(a) )However, for 2020, the ARP Act allows individuals to exclude from income up to $10,200 of unemployment compensation. For married individuals filing a joint return, this exclusion is up to $10,200 per spouse (“unemployment compensation exclusion”).

To qualify for the unemployment compensation exclusion, adjusted gross income (AGI) must be less than $150,000. This threshold applies to all filing statuses, i.e, it does not double to $300,000 for married individuals filing a joint return. Any unemployment compensation over $10,200 ($10,200 per spouse if married filing jointly) must be included on the tax return as taxable income.

IRS reviewing returns. The IRS has identified over 10 million individuals who reported unemployment compensation and filed their 2020 tax returns before ARPA was enacted in March 2021. The IRS is reviewing these tax returns, in phases, to determine the correct taxable amount of unemployment compensation and tax.

Phase one, which is underway, includes the simplest returns (single taxpayers who did not claim children or any refundable tax credits).

Phase two, which will begin after Phase one is complete, will include more complex tax returns such as those of couples filing as married filing jointly.

The IRS anticipates that it will take through the end of the summer to review and correct Phase two returns.

As part of its review process, the IRS will correct any claimed Earned Income Tax Credit (EITC) for individuals and couples without children, and the Recovery Rebate Credit.

However, taxpayers who, after the unemployment compensation exclusion is applied to their return, are now eligible for certain income-based tax credits not claimed on their original return (such as couples with qualifying children who, as a result of the exclusion, became eligible to claim the EITC) should file an amended tax return to claim those credits.

IRS will issue refunds when appropriate. After reviewing a return, the IRS will make any corrections related to the unemployment compensation exclusion automatically. The IRS will then issue any refunds resulting from its review of, and corrections to, a taxpayer’s 2020 return.

Refunds will be issued via direct deposit for taxpayers who provided bank account information on their 2020 return. If bank account information is not available (or isn’t valid), any refund will be mailed as a paper check to the taxpayers’ address of record.

The IRS will also send taxpayers a notice explaining any corrections the IRS made to their 2020 return. Taxpayers should keep any notices they receive for their records. The IRS says that taxpayers should receive these notices within 30 days of the IRS making a correction to their return.

Refunds subject to offset. Any refunds issued as a result of the IRS’s review of and corrections to a taxpayer’s return are subject to normal offsets, such as past-due federal tax, state income tax, state unemployment compensation debts, child support, spousal support, or certain federal nontax debts (i.e., student loans). The IRS will send a separate notice to the taxpayer if the refund is offset to pay unpaid debts.

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