If you find yourself among the 9% who are unemployed, you probably have more important things on your mind than the tax consequences or tax breaks that may help or hinder your financial welfare. But there are some key things unemployed taxpayers need to know when looking ahead to filing your 2011 tax return next April 15.
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Severance packages, accumulated sick leave, vacation and holiday pay are all taxable income. When you are terminated from your job, you may receive this additional pay and be surprised, like a friend of mine recently was, to find that it’s taxable. These amounts will have taxes deducted and will be declared on your W2.
Unemployment benefits are taxable income. I call this the “kick-you-while-you’re-down” legislation. Be ready to pay taxes on your unemployment checks.
You can ask the government to withhold 10% of the payments in order to prepay the resulting tax liability. Simply complete IRS Form W-4V and submit it to your state unemployment department, it will provide form 1099-G by Jan. 31 to show how much you received in benefits. The IRS will be looking for this number on your tax return.
Withdrawals from retirement plans and IRAs are generally taxable, and if you’re under age 59 ½ you may be subject to a 10% early-withdrawal penalty (your state may assess a penalty as well). There are some exceptions to this penalty, check out Publication 575 available at www.irs.gov.
If you roll over your retirement fund or pull money out for 60 days then redeposit the entire amount into a qualified retirement plan, you can escape the penalty.
Loans and gifts from family and friends are not taxable income. Bank loans or credit card cash advances are also not subject to tax. Money received from credit card company insurance carriers to cover your monthly payments while unemployed is not taxable income. Public assistance, welfare and food stamps, are not taxable income either.
Debt forgiveness may be subject to income tax. Because you are unemployed, you may not have the ability to repay existing debt. If a creditor writes off the balance owing or reduces your balance by forgiving some of the debt, you are liable for income taxes on the amounts forgiven. You will receive a Form 1099 by Jan. 31 indicating the amount that is taxable.
However, if you file bankruptcy none of the forgiven debt is taxable income. If you are insolvent, you may escape a tax liability to the extent of insolvency. To determine this, add up the value of all of your assets on the eve of the debt forgiveness. Then add up the value of all of your debt. Subtract the debt from the assets. If the result is a negative number, then you are insolvent to that extent.
For example, your assets total $100,000 and your debt is $120,000 resulting in insolvency of $20,000. The credit card company forgives a balance of $30,000. You would have to pay taxes on $10,000: the difference between your insolvency and the balance owing.
Tax Benefits. You may find additional tax benefits because you are unemployed. First of all, your decrease in income will likely throw you into a lower tax bracket. Because of this, you may enjoy a refund. If your earned income is low enough, you may qualify for the Earned Income Tax Credit (EITC), and the additional Child Tax Credit, which will result in an even bigger refund.
Also, do not forget to track job search expenses as they are deductible. If you go back to school, you may qualify for the American Opportunity Credit or an education deduction for college tuition, books, fees, and computer equipment.
And, if you are lucky enough to snag a new job and the job requires a move, you may be able to deduct moving expenses. Check out IRS Publication 521 to determine if you meet the time and distance requirements and to find out which expenses are deductible.
But don’t get excited thinking you can file your 2011 income tax return before the year is over to enjoy the refund. Not possible. First of all the forms aren’t even out yet, and secondly, the IRS wants you to wait. Who knows? You might land the job of your dreams and be getting another W2 or you may win the lotto.
If you have a tax liability from prior years and are on an installment plan, you will likely be able to put off repayment because you are unemployed. Call the IRS and let them know your situation. They can deem you “uncollectible,” giving you a year to pull it together before they begin collection efforts again. If another year passes and you are still unemployed, it will renew the “uncollectible” status. Penalties and interest will continue to accrue, but you will be relieved of the debt.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.