Income tax subtraction for unemployment benefits? New legislation would bring it back

Remember that debate during last year’s legislative session – and June’s special session – about whether there should be an income tax subtraction for unemployment benefits? Well, it’s back.

That provision in the omnibus tax bill signed into law at the beginning of July actually related strictly to the 2020 tax year. So, as of now, those looking to subtract unemployment benefits from their taxable income on state income tax forms will find that they can’t.

To the rescue rides HF2765, a bill sponsored by Rep. Zack Stephenson (DFL-Coon Rapids). It would create the same temporary tax subtraction for tax year 2021 as was in effect for tax year 2020, with up to $10,200 in unemployment benefits subtractable from taxable income.

On Wednesday, the bill, as amended, was laid over by the House Taxes Committee for possible inclusion in an omnibus tax bill. It currently has no Senate companion.

If it becomes law, the temporary change would affect about 320,600 filers this year, their taxes dropping by an average of $500. That’s according to the Department of Revenue, which estimates that state revenue would drop by about $160.9 million in fiscal year 2023 as a result.

For married taxpayers filing a joint return, the subtraction would be limited to $10,200 in unemployment compensation received by each spouse. It would also be subject to an income-based phaseout beginning at $150,000 of adjusted gross income for married taxpayers filing a joint return, or $75,000 for all other filers.

“The economic difficulties from COVID-19 persisted into 2021, and we want to continue the approach we took in 2020,” Stephenson said. “While unemployment insurance claims fell between 2020 and 2021, they’re still significantly higher compared to 2019, particularly in the areas of educational services, health care services and the retail trade.”

During 2021, 433,000 individuals received a total of $5.7 billion in unemployment insurance payments, according to the state’s Department of Employment and Economic Development (DEED).

“When we did this last year, it was probably more of a conformity issue, since the federal government was doing it,” said the committee’s chair, Rep. Paul Marquart (DFL-Dilworth). “This year, Minnesota would be doing this on its own. Much like last year, DEED did not withhold anything. Which means that folks are going to get a bit of a sticker shock when they get their tax bill and see that nothing was withdrawn from this extra income.”

If it becomes law, HF2765 would soften the shock.