How unemployment affects your income taxes
If you lost your job last year, you might be in for some surprises when you file your tax return.
If you got laid off near the end of the year with a big severance package or if you cashed in a retirement account, you could end up owing more than expected. Conversely, if you got laid off early in the year with no severance, you might be entitled to some tax write-offs that you previously earned too much to take.
Here's a look at some tax issues awaiting you:
Unemployment benefits: Unemployment benefits are taxable on your federal return except for the first $2,400 in benefits, which are tax-free for 2009. Unemployment benefits are not subject to Social Security or Medicare tax. Nor are they taxable on your California income tax return, although some other states tax them.
If you did not choose to have 10 percent of your unemployment check withheld for federal taxes and did not make estimated tax payments, you could owe more than you were expecting.
Severance: The pay is subject to federal and state income tax, Medicare and Social Security tax. (Earnings, including severance, that exceed $106,800 in 2009 are not subject to Social Security tax.)
If you get a lump-sum severance payment, tax is withheld at a flat rate, generally 25 percent for federal and 6 percent for California income tax. The amount withheld could be more or less than what you actually owe, resulting in a positive or negative surprise when you file your return.
A very generous severance package could push you into a higher bracket, especially if it followed many months of salary. It could cut into or eliminate some tax breaks that phase out at higher income levels, such as itemized deductions, personal exemptions, education -related credits and deductions, the Making Work Pay credit, the federal tax credit for first-time home buyers, and the sales tax deduction for a new-car purchase in 2009.
Miscellaneous expenses (such as investment and tax-preparation fees, unreimbursed business expenses and job-hunting costs) and unreimbursed medical expenses are not deductible until they exceed a certain percentage of your adjusted gross income, so if your income jumps, they become harder to get. You also could become ineligible to contribute to a Roth IRA or deduct a contribution to a regular IRA.
Retirement distributions: If you took money out of your former employer's 401(k) plan in 2009 and did not roll the proceeds into an IRA within 60 days, that money will be added to your income and subject to federal and state income tax.
You also could owe a 10 percent penalty on money you took out of the 401(k) plan unless you were 55 or older in the year you terminated your employment or qualify for a different exception.
If you took money from an IRA, it will be subject to income tax. You also could face a 10 percent penalty unless you are at least 59 1/2 or qualify for a different exception.
"If you are taking money out (of a retirement plan) to pay for a kid's education, do not take it from your 401(k), take it from your IRA. There is an exception
to the 10 percent penalty if you take money out of an IRA - but not a 401(k) - to pay for college," says Bob Scharin. senior tax analyst with the Tax & Accounting business of Thomson Reuters.
If you had a loan from your 401(k) when you were laid off and didn't repay it soon thereafter, the balance is usually treated as a withdrawal, meaning it's subject to income tax and potentially a 10 percent penalty.
Outplacement: If your former employer offered you job placement assistance, its value is tax-free unless you had a choice of taking cash instead. If you had this choice, the income will be reported on your Form W-2, Scharin says.
New tax breaks: If unemployment caused your income to drop substantially in 2009, you could become eligible for new tax breaks.
For example, if you itemize deductions, you can deduct out-of-pocket medical expenses - including health insurance premiums - that exceed 7.5 percent of your adjusted gross income.
If your income plummeted and your medical expenses went up in 2009, you might qualify for this hard-to-get deduction, as long as you itemize.
If you are paying Cobra insurance premiums, "even if you are getting the federal subsidy, you are probably paying more than you did during your working years," Scharin says.
Over-the-counter drugs, except for insulin, don't qualify for this deduction. For more details, search for Publication 502 at www.irs.gov .
A drop in income could make you eligible for tax benefits that are off-limits to wealthier taxpayers, such as those for higher education expenses, the first-time home purchase credit, the new-car sales tax deduction and the Saver's Credit.
You also might fall below an income limit that would allow you to put money in a Roth IRA or make a deductible contribution to a regular IRA. For details, see IRS Publication 590. If you qualify, you have until April 15 to make a contribution for 2009.
Job-search expenses: You might be able to deduct job-search expenses if you are looking for a job in the same occupation, even if you don't get one. Qualified expenses include printing and mailing resumes, job counseling and employment agency fees, employment-related phone calls and unreimbursed travel to and from interviews.
Add these to your other miscellaneous expenses. If the total exceeds 2 percent of your adjusted gross income, you can deduct the portion over 2 percent as an itemized deduction.
You cannot deduct expenses if this is your first real job or you've been out of work for a long time. For details, see IRS Publication 529.
Moving expenses: If you had to move to get a new job, you might be able to deduct certain moving expenses, says John Brychel. a partner with accounting firm Armanino McKenna. To qualify, you must move at least a certain distance and work in your new job for a minimum amount of time. For details, see IRS Publication 521.
Self-employment: If you have income from freelance or consulting jobs, you will report it on Schedule C. You may be able to deduct some business-related expenses. You also could be liable for self-employment taxes on top of your income taxes.Source: m.sfgate.com