Despite the fact that there have recently been encouraging economic signs, the national unemployment rate continues to inch higher. At the end of April, the unemployment rate was 8.9%. By the end of May, it stood at 9.4% and in a June interview with Bloomberg News, President Barack Obama predicted that the country will soon see a 10% unemployment rate.
As shocking as it is to lose a job, it’s even worse when you suddenly realize that there are also tax consequeneces to deal with. Be aware that severance pay and unemployment compensation are taxable. Payments for accumulated vacation or sick time are also taxable. Make sure that enough taxes are withheld from these payments or arrange to make estimated payments.
There is one bright spot — you get a bit of a break this year thanks to the American Recovery and Reinvestment Act of 2009. This new law temporarily excludes up to $2,400 of unemployment compensation from a recipient’s gross income. Remember, this is for 2009 only and anything over $2,400 is fully taxable.
Sometimes unemployed individuals resort to withdrawing money from their IRAs and qualified retirement plans. This creates another tax issue and is not a course of action that we recommend. Generally speaking, if you withdraw money before you reach eligible age and don’t roll it into another plan within 60 days, that amount must be reported as taxable income. One exception allows an umemployed individual to take penalty-free distributions from an IRA to pay health insurance premiums. This exception does not apply to qualified plans. In addition to possible taxes, your IRA or qualified plan withdrawal may be subject to a 10% tax on the early distribution.
The other big question is whether or not expenses incurred while looking for a new job are tax deductible. Don’t rely on your peers for the answer to this question! Check with a tax professional or see IRS Publication 529, Miscellaneous Deductions. As a rule, you can deduct employment agency fees, resume preparation and travel expenses associated with job interviews.
The Lange team sincerely hopes that unemployment tax issues aren’t something you have to deal with this year. However, if you find yourself in this situation, you can get detailed information at www.irs.gov.
We also suggest that if you are facing unemployment, but have the means to make a Roth IRA conversion, you give it serious consideration. You would likely be in the lowest income-tax bracket of your life — the perfect time to make a Roth IRA conversion. As always, our office is available to help with Roth IRA conversion analysis.