Unemployment benefits are taxable income for federal income taxes, although states usually exempt unemployment benefits from state income taxes.
For 2009 only, the first $2,400 in unemployment benefits will be exempt from federal income taxes, due to a provision in the American Recovery and Reinvestment Act. Benefits in excess of this amount are still subject to federal income taxes.
Reporting Unemployment Benefits
State unemployment insurance funds report your total unemployment benefits for the year on Form 1099-G. You'll report your benefits on your tax return using Form 1040EZ, 1040A, or 1040.
Tax Law Regarding Unemployment Compensation
"Unemployment compensation generally includes any amounts received under the unemployment compensation laws of the United States or of a state. It includes state unemployment insurance benefits and benefits paid to you by a state or the District of Columbia from the Federal Unemployment Trust Fund. It also includes railroad unemployment compensation benefits and disability benefits paid as a substitute for unemployment compensation, but not worker's compensation." (from IRS Tax Topic 418)
