Unemployment rates are trending down, but that doesn’t mean that jobs are easier to find or keep in this sluggish economy. If you are or were unemployed in the past year, there are some important things you should know before you file your taxes.
What Is Taxable?
Even if you’re unemployed, you still have to pay federal income taxes on any income you received during the year you’re filing for. In addition, you may have received other types of payments while you were unemployed and the tax implications of those may be unclear. Here are some of the payments that are taxable.
- Income and severance pay: In addition to any income you received from your employer while employed, any income you received while unemployed is also taxable. If you received any kind of severance pay after being laid off, you will have to pay taxes on it.
- Vacation or sick time: Generally, if you get laid off, your employer will pay you for any accumulated vacation or sick time that you did not take. This payment is also taxable as income. If your employer did not withhold taxes from these payments, as well as your severance pay, you should make sure you set aside an estimated amount to pay when tax time rolls around.
- Unemployment benefits: Any unemployment compensation you receive is still taxable by the federal government. This is something that many who receive unemployment may not realize until tax season, when they are faced with a nasty and expensive, surprise. If you receive unemployment compensation, it might be a good idea to consider having federal income taxes withheld, similar to the payroll withholding from paychecks.
- Pension plan: Withdrawals from your pension plan are generally taxable, unless they are transferred to a qualified plan, such as an individual retirement account (IRA). If you are under the age of 59 ½, an additional tax may apply to the taxable portion of your pension.
It’s not all bad news. The federal government does allow some deductions for unemployed taxpayers. These are some of the deductions you may be eligible for.
- Job search expenses: You can deduct certain expenses incurred while looking for a new job. These include employment or outplacement agency fees and resume preparation fees. In addition, travel expenses related to your job search, like transportation to and from interviews, can also be deducted.
- Moving expenses: If you incurred expenses because a change in your job location, those expenses may be deductible, as long as you meet the time and distance requirements. Generally, your move must occur within a reasonable time of the start of your new job. You must also have moved at least 50 miles.
- Medical expenses: You may be able to deduct medical and dental expenses that you paid for yourself, your spouse or your dependents. The amount you deduct must have exceeded 7.5% of your adjusted gross income during the year you are paying taxes for. If you received continued health coverage under the Consolidated Omnibus Budget Reconciliation Act of 1985 (Cobra), you probably cannot deduct those medical expenses. If you made contributions to a Health Savings Account (HSA) you may be able to deduct those contributions, even if you do not itemize your deductions. To qualify, you must be covered under a high deductible health plan, have no other health coverage, and you must not be enrolled in Medicare.
(Also read: Tax Breaks Everyone Should Know.)
Other Tax Breaks For The Unemployed
In addition to these deductions, there are other tax breaks you can take if you’re unemployed. Any public assistance or food stamps you received will not be taxed. Another tax break to look into is the earned income tax credit. Unemployment likely lowered your total income for the year, which might make you eligible for the credit, which is aimed at low to moderate income working individuals and families. The credit allows you to receive a tax refund if the credit exceeds the amount of taxes owed.
If You Can’t Pay Your Taxes
Without a job, and a steady income, you may find that when tax time rolls around, you don’t have enough money to pay all of your taxes. So, what should you do?
- Internal Revenue Service penalties: If you’re tempted to ignore the problem, don’t do it. Even if you cannot pay, you should always file your taxes. The IRS penalties for not filing are worse than the penalties for not paying. The penalty for filing late is usually 5% of the unpaid taxes for each month or part of a month that a return is late. The penalty will not exceed 25% of your unpaid taxes. The failure to pay the penalty is usually ½ of 1% of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty will also not exceed 25% of your unpaid taxes.
- IRS payment plans: If you find that you are unable to pay your taxes, you can make monthly payments through an installment agreement with the IRS. The payment plan will reduce or eliminate the amount of penalties and interest you pay, but you will be subject to certain fees. For a direct debit agreement, it costs $25, and for a standard agreement or payroll deduction agreement it costs $105. Before you apply for a payment plan, you should file your taxes. You should also consider other sources, including a loan or a credit card, to pay your taxes if it saves money.
Knowing the tax consequences and benefits of being unemployed is important and can even save you some money on your tax returns. The most important thing to remember is that you should always file your taxes, even if you cannot pay them fully. If you have any questions about filing your taxes, you can check the IRS website at Irs.gov or you can call its toll-free tax assistance line at 800-829-1040.