If you or your spouse collected unemployment benefits in 2012, be sure you count that money as gross income when you file your tax return.
It may come as a surprise to some workers, but unemployment compensation from your state is taxable. In fact, there's a specific line on the 1040, 1040A and 1040EZ forms for you to add the amount to gross income.
In January of each year, your state will send you and the IRS Form 1099-G to report the amount of unemployment benefits paid to you the previous year.
Unemployment compensation is not wages and there is no Social Security or Medicare tax withheld from the payment. Unemployment is also not earned income so you can't use unemployment compensation to obtain the Earned Income Tax Credit.
Most states will not withhold any income tax from these benefits unless you specifically request it. Consider withholding taxes from your unemployment checks or else you may find yourself owing taxes. Making quarterly estimated tax payments is another way to avoid this unpleasant surprise. You can find more information on this subject in IRS Tax Topic 518.
If you have a dependent child who was laid off and is eligible for unemployment benefits, there is a risk that your child may be subject to what many refer to as the "Kiddie Tax" (tax on a child's investment income). This happens when a dependent child has investment income in excess of $1,900, which will be taxed at the parent's tax rate. Most of us think of investment income as interest, dividends and capital gains sourced from investment property. When it comes to the Kiddie Tax, it includes just about all unearned income the child receives, including-you guessed it-unemployment compensation. When this happens, the child's tax return cannot be prepared until the parent's return is finished. For more information on a child being taxed at the parent's rate see IRS Tax Topic 553.