The American Rescue Plan Act of 2021 (ARPA) provision that contains an exclusion for up to $10,200 of 2020 unemployment benefits also provides that the exclusion is not taken into consideration in computing modified adjusted gross income (modified AGI) for various purposes. IRS has now set out, in a manner that might not be obvious to practitioners, how to reflect this modified AGI rule, and how to reflect what appears to be an IRS-created modified AGI rule on 2020 tax returns.
Background—ARPA’s unemployment exclusion provisions.
ARPA, which was signed into law on March 11, provides that, for taxpayers whose 2020 modified adjusted gross income is less than $150,000, the first $10,200 of unemployment compensation received in 2020 is not included in the taxpayer’s 2020 gross income. In the case of a joint return, the first $10,200 per spouse is not included in gross income. (Code Sec. 85(c)(1), as amended by ARPA Sec. 9042(a))
That ARPA provision also listed a series of provisions that involve calculating various forms of modified AGI and provided that the unemployment exclusion does not affect these various calculations of modified adjusted gross income. (various Code sections as amended by ARPA Sec. 9042(b))
Background—reporting unemployment benefits and the exclusion on Form 1040.
Unemployment benefits are reported as income on Form 1040, Schedule 1, Line 7. Form 1040, Schedule 1, Line 8 is captioned as “Other income.”
The exclusion is computed on a new worksheet, the Unemployment Compensation Exclusion Worksheet. Line 3 of that worksheet is Schedule 1, Line 8 before considering the exclusion. Line 11 of that worksheet is Schedule 1, Line 8 minus the exclusion. The amount from Line 11 of the worksheet is then transferred to Schedule 1, Line 8.
In other words, Schedule 1, Line 8, although captioned “Other income,” is actually other income minus the unemployment benefit exclusion.
Various forms and worksheets used to compute amounts that are reported on Form 1040 or on one of the Form 1040 schedules refer to Form 1040, Schedule 1, Line 7 and/or Schedule 1, Line 8 in their calculation of modified AGI. See, for example, the Line 9 Worksheet in the instructions section of Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989
How to report the unemployment exclusion when computing modified AGI.
When figuring the following deductions or exclusions from income, if you are asked to enter an amount from Schedule 1, Line 7, enter the total amount of unemployment compensation reported on line 7 (unreduced by any exclusion amount). If you are asked to enter an amount from Schedule 1, Line 8, enter the amount from Line 3 of the Unemployment Compensation Exclusion Worksheet.
The following forms and instructions provide more information on these calculations:
- Taxable social security benefits (Instructions for Form 1040 or 1040-SR, Social Security Benefits Worksheet)
- IRA deduction (Instructions for Form 1040 or 1040-SR, IRA Deduction Worksheet)
- Student loan interest deduction (Instructions for Form 1040 or 1040-SR, Student Loan Interest Deduction Worksheet)
- Nontaxable amount of Olympic or Paralympic medals and USOC prize money (Instructions for Form 1040 or 1040-SR, Schedule 1, Line 8)
- The exclusion of interest from Series EE and I U.S. Savings Bonds issued after 1989 (Form 8815)
- The exclusion of employer-provided adoption benefits (Form 8839)
- Tuition and fees deduction (Form 8917)
- The deduction of up to $25,000 for active participation in a passive rental real estate activity (Form 8582)
The key element of the above instructions is that where the abovementioned forms ask you to enter the amount from Form 1040, Schedule 1, Line 8, if you’ve taken the exclusion, do not enter the amount from Form 1040, Schedule 1, Line 8. Instead, enter the amount from Line 3 of the Unemployment Compensation Exclusion Worksheet.
The effect of these instructions is to keep the exclusion from reducing modified AGI for purposes of the listed forms. In other words, these instructions put into effect the ARPA Sec. 9042(b) rule mentioned above.
The IRS-created modified AGI rule.
As noted under “Background—ARPA’s unemployment exclusion provisions,” above, the exclusion is available to taxpayers whose 2020 AGI is less than $150,000. However, the Unemployment Compensation Exclusion Worksheet provides the following instructions for computing 2020 AGI for this purpose:
- If you are filing Form 1040 or 1040-SR, enter the total of lines 1 through 7 of Form 1040 or 1040-SR. If you are filing Form 1040-NR, enter the total of lines 1a, 1b, and lines 2 through 7.
- Enter the amount from Schedule 1, lines 1 through 6. Don’t include any amount of unemployment compensation from Schedule 1, line 7 on this line.
- Use the line 8 instructions to determine the amount to include on Schedule 1, line 8, and enter here. Do not reduce this amount by the amount of unemployment compensation you may be able to exclude.
- Add lines 1, 2, and 3.
- If you are filing Form 1040 or 1040-SR, enter the amount from line 10c. If you are filing Form 1040-NR, enter the amount from line 10d.
- Subtract line 5 from line 4. This is your modified adjusted gross income. (emphasis added)
Thus, IRS has omitted unemployment benefits from the calculation of AGI for purposes of determining whether a taxpayer qualifies for the exclusion’s less-than-$150,000 threshold. In other words, while the Code provides that the threshold is based on AGI, IRS is computing the threshold based on AGI modified to eliminate unemployment benefits.
This IRS-created change was not in the original version of IRS webpage – New Exclusion of up to $10,200 of Unemployment Compensation, i.e., the version posted on March 16, 2021.
While tax preparation software should implement all of the above IRS instructions without any actions on the part of the preparer, given the compressed time frame facing the tax software industry in making the required changes, it would probably be worth your time to check your tax return preparation software to see if it reflects these IRS instructions.
To continue your research on tax treatment of unemployment compensation, see FTC 2d/FIN ¶ H-3007.
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