Tough Times Series: The Tax Consequences of Unemployment/ November 13th, 2010
You've probably heard there's nothing certain but death and taxes. The old saying holds true, even in an uncertain economy. Even when you lose your job, you still have to pay taxes. As of late summer 2010, there were 14.6 million people out of work in the U.S., making for a national unemployment rate of 9.5%, according to the U.S. Labor Department.
Your tax responsibilitiesThe hard truth is that unemployment compensation is taxable. So is severance pay and payment for accumulated sick leave. Payments for unused vacation time are taxable as well. Under the American Recovery and Reinvestment Act (ARRA)—or the stimulus package, as it's more commonly known—the first $2,400 of unemployment compensation individuals received in 2009 were tax-exempt. But that benefit has expired. "At this point, the $2,400 exemption for unemployment compensation applies to income for 2009," says Christopher Miller, media relations spokesperson with the Internal Revenue Service (IRS). "We cannot speculate on what may or may not occur in the future." Not everything is taxable. If you're eligible for food stamps, those aren't taxed. You usually don't pay taxes on gifts, unless they produce income (such as interest, dividends, or rent). Also, note that we're only discussing federal taxes, not state taxes. Some states tax unemployment compensation and some don't. Check local regulations to see how they affect you.
Plan aheadIf you've recently been laid off, next year's taxes might seem like the least of your worries. Still, plan ahead so you don't face a jaw-dropping bill when you file. You have two basic options: Arrange for federal withholding, or make estimated tax payments.
Plan ahead so you don't face a jaw-dropping tax bill when you file.Choosing withholding gets the federal government to do what your employer did: take cash out of your checks to cover taxes. But you can't vary the rate—government withholding is a flat 10%. Sign up for withholding by filling out Form W-4V. You also can estimate your tax with Form 1040-ES and make quarterly payments. Just be sure you make those payments, and account for all of your income.
Negotiate with the IRSIf you think you won't be able to pay your taxes, call the IRS at 800-829-1040 to discuss your options. The agency may be able to offer you:
- A short-term extension to pay;
- An installment agreement (using Form 9465);
- An offer in compromise; or
- A penalty waiver, in some cases.
Tax benefits of unemploymentUsing unemployment tax benefits takes work. You'll need to file Form 1040-A—the "long form"—and itemize expenses. That effort lets you deduct these job-hunting expenses:
- Employment agency fees—These could count as income if an employer reimburses you.
- Phone calls—You can deduct local and long-distance calls to job contacts.
Going back to school can make you eligible for tax credits or deductions.
- Résumé services—This includes the cost of writing, printing, and mailing résumés.
- Travel—If you're hitting the road for a job interview or search, you can deduct related expenses.
Health insurance and unemploymentPeople laid off through no fault of their own can purchase health insurance at group rates through the Consolidated Omnibus Budget Reconciliation Act (COBRA) for up to 18 months, or even longer if you have a qualifying disability. Your premiums will be lower than they would be if you bought insurance as an individual, but they still add up. If you were laid off between Sept. 1, 2008, and May 31, 2010, you may be eligible for a federal subsidy covering 65% of your COBRA payments for 15 months. However, this benefit expired for people laid off after June 1, 2010. Health-insurance premiums still are deductible—as long as you file Schedule A and your total unreimbursed medical expenses are more than 7.5% of your adjusted gross income. You also can use your IRA (individual retirement account) to cover health-insurance costs for yourself, your spouse, or your dependents, even if you're not age 59½. If you've been unemployed for 12 weeks or more, you won't face penalties.
You can deduct some job-hunting expenses.
Get credit for creditsGoing back to school, or taking courses to become more employable, can make you eligible for tax credits or deductions. See if you meet the qualifications for these credits:
- The American Opportunity Credit, available only for the 2009 and 2010 tax years, offers up to a $2,500 tax credit.
- The Lifetime Learning Credit provides up to a $2,000 tax credit.
- The Tuition and Fees Deduction can reduce taxable income by up to $4,000, and you won't need to itemize deductions.
Worth a second lookIf you're earning a lot less this year than you earned in the past, you may qualify for these tax credits and deductions, which are phased out for people with higher incomes:
- Child Tax Credit
- Deduction for Dependent Care
- Earned Income Tax Credit