ABC Taxes, Tips & Tools

It’s a ter­ri­ble event that many peo­ple are fac­ing these days, the job loss of a sig­nif­i­cant bread­win­ner. Pro­longed unem­ploy­ment may have ram­i­fi­ca­tions that may com­pletely alter your eco­nomic posi­tion and have tax con­se­quences beyond what you might imag­ine.  In this blog we dis­cuss var­i­ous ques­tions in a super­fi­cial man­ner in order to elab­o­rate on pos­si­ble effects of job loss on your finan­cial life in order to make you aware of them.

What is tax­able income in the unem­ploy­ment sce­nario? Assum­ing that you are eli­gi­ble you may receive unused vaca­tion pay, sev­er­ance and unem­ploy­ment com­pen­sa­tion.   All of these pay­ments are tax­able income.  In Ari­zona you can­not start receiv­ing unem­ploy­ment until you have been paid your unused vaca­tion and severance.

Who pays the with­hold­ing taxes? In gen­eral your employer should with­hold taxes from your unused vaca­tion pay and sev­er­ance, but if not then you are respon­si­ble.  Unem­ploy­ment pay­ments may or may not have taxes with­held.  In Ari­zona you can elect to have money with­held to cover state and fed­eral income taxes or not.  Unem­ploy­ment is income but not earned income – Unem­ploy­ment is sub­ject to income tax only, but sev­er­ance and unused vaca­tion pay must have the 7.65% (employee por­tion) of social secu­rity & Medicare with­held in addi­tion to income tax.

When will I get my W-2? Even those employ­ers who go out of busi­ness are sup­posed to deliver the W-2 by the usual due date, which is Jan­u­ary 31 of the year fol­low­ing, although an employer can deliver one sooner.  But it is advis­able for you to keep your final paystubs show­ing your total with­hold­ing and your total income until you receive your W-2. If the final pay stub does not show a total with­hold­ing and total income, then you may need to keep more paystubs to esti­mate these amounts.  In the event your employer goes out of busi­ness or oth­er­wise does not sup­ply a W-2 you can use the final pay stub to cre­ate a sub­sti­tute W-2 so you can file your taxes.

Pay­ing Esti­mated Taxes. If you need to pay esti­mated tax you can com­plete a form 1040 ES and make pay­ments to the fed­eral gov­ern­ment.  Remem­ber, the US tax sys­tem is pay as you go.  If you under­pay your tax with­hold­ing, you will be charged a penalty and inter­est.  Safe har­bor is greater of: Under $1000 OR, 90% of all of your taxes owed for the cur­rent year OR, 100% of the tax you owed last year unless you earned more than $150,000 then its 110%. We rec­om­mend you obtain the Form 1040ES from IRS.gov (use the IRS search box); the work­sheet on Form 1040ES can help you deter­mine what you may owe and how much.  If you do deter­mine you have with­hold­ing tax lia­bil­ity you will need to fig­ure out how much you need to pay each quar­ter to make up the deficit.  The deposit due dates for Cal­en­dar year tax­pay­ers are April 15, June 15, Sep­tem­ber 15 and Jan­u­ary 15 of the year fol­low­ing; NOTE these pay­ments are not spread evenly through­out the year.  Even if you pay all you need to by Jan­u­ary 15 of the year fol­low­ing, you may owe a penalty if you under­paid in any quar­ter. The Ari­zona esti­mated tax Form, 140ES, is used to make with­hold­ing pay­ments to the state of Ari­zona – the  Ari­zona income thresh­old is $75,000, but in gen­eral it is ben­e­fi­cial to pay at least some of the tax you will owe as you go, instead of com­ing up with the entire amount due at tax time.  The due dates of Ari­zona esti­mated tax pay­ments are the same as the Fed­eral due dates.

Who is eli­gi­ble for the COBRA sub­sidy? Med­ical insur­ance is a big issue for many laid off work­ers. Often times you will get the COBRA offer and decide it is too expen­sive; you may opt to obtain less expen­sive cov­er­age or go with­out.  How­ever for some peo­ple, who have been laid off between Sep­tem­ber 1, 2008 and Decem­ber 31, 2009 there is the COBRA sub­sidy, which pays 65% of the COBRA pay­ment for 9 months; this sub­sidy may make retain­ing med­ical cov­er­age afford­able to many more tax pay­ers — at least 9 months that it is offered.  Be sure to ask for it if you qual­ify, when you receive your COBRA paperwork.

Health Insur­ance. The cost of health insur­ance may be deductible if you item­ize deduc­tions on your tax return (File Sched­ule A with form 1040).  The total of med­ical expenses that exceed 7.5% of your income is deductible on your Sched­ule A. For exam­ple, if your income was $20,000 then you would only be able to deduct med­ical expenses includ­ing health insur­ance that exceed $1500 and only if you item­ize deduc­tions.  HSAs. If you qual­ify for an HSA, you can claim a tax deduc­tion for con­tri­bu­tions made by you, your employer or some other per­son, to your HSA even if you do not item­ize deduc­tions on your tax return.

Is Pub­lic Assis­tance or Food Stamps Tax­able? No.

Are gifts tax­able? Gen­er­ally the gift tax is paid by the giver NOT the recip­i­ent.  If the gift pro­duces income, inter­est, div­i­dends and the like, the recip­i­ent is respon­si­ble for pay­ing taxes on the income pro­duced.  Cer­tain gifts paid directly to med­ical insti­tu­tions or edu­ca­tional insti­tu­tions on behalf of the recip­i­ent may not incur a gift tax.  Givers can gift up to $13,000 per per­son in 2009 with­out incur­ring a gift tax, but real­ize this max­i­mum gift amount includes cash, but also presents, cards etc.; a giver should be wary about giv­ing the whole $13,000 in cash to a per­son; a lesser amount that will allow for the odd birth­day gift, greet­ing card etc. is more advisable.

Can I file early? Tax returns can­not be filed early even if you antic­i­pate that you will receive a hefty refund.  The soon­est a tax return can be filed is Jan­u­ary 2 of the year fol­low­ing (Jan­u­ary 1 is a hol­i­day after all).

Stocks and Bonds and other with­drawals. If you cash out stocks or bonds, you may owe taxes on the prof­its from these sales.  The amount you paid for these stocks or bonds is usu­ally not tax­able; only the amount received above the amount paid and cost of dives­ture is tax­able.  You will need to include this income in your income and also include it when fig­ur­ing your esti­mated taxes.

Retire­ment accounts.  The usual rules are in effect for IRAs and other tax advan­taged retire­ment accounts, even when you are laid off.  If you do a trustee to trustee trans­fer you can roll you retire­ment account over to another retire­ment account tax-free, how­ever if you opt to receive the money before rolling it over, most trustees will with­hold 20% from the amount dis­trib­uted to you.  If you decide to put the money back into a retire­ment account within 60 days you will need to make up the amount with­held by the trustee in order to avoid pay­ing the taxes and penalty for early with­drawal of it.  If it is your intent to just roll the money over, a trustee to trustee trans­fer is the best way to go.

With all rollover trans­ac­tions there are sev­eral pro­hib­ited trans­ac­tions: Bor­row­ing from the dis­tri­b­u­tion, receiv­ing undue com­pen­sa­tion for man­ag­ing these funds, buy­ing per­sonal prop­erty for future or present use, or using the dis­tri­b­u­tion as secu­rity for a loan.  If you engage in a pro­hib­ited trans­ac­tion the retire­ment account will lose its tax-advantaged sta­tus as of Jan­u­ary 1 of the year in which the pro­hib­ited trans­ac­tion occurred and all taxes will be due on the amounts in that account includ­ing the penal­ties for early with­drawal etc.

If you decide to make a with­drawal from your IRA or other retire­ment account before eli­gi­ble age you will owe income taxes but also may owe a penalty for early with­drawal.  The rules vary from plan to plan so it is advis­able to talk to the plan admin­is­tra­tor about your options before mak­ing a withdrawal.

There are a few excep­tions to the early with­drawal penalty such as dis­tri­b­u­tions pur­suant to a QDRO, per­ma­nent and total dis­abil­ity, money used to pay med­ical expenses in excess of 7.5% of your income etc.

If, in the cur­rent year, you paid money into an IRA and with­draw that amount plus any inter­est earned by that deposit before year’s end, you can with­draw that amount with­out incur­ring a penalty, but you must add it and the asso­ci­ated inter­est to back into your income.

If you made pre­vi­ous non tax-advantaged con­tri­bu­tions to an IRA you will need forms 8606 from those years, and you will need to fig­ure out how much of your IRA dis­tri­b­u­tion is tax­able using a work­sheet in the Fed­eral Pub­li­ca­tion 590, Indi­vid­ual Retire­ment Arrange­ments; a pdf of this pub­li­ca­tion  can be down­loaded from IRS.gov or you can visit your local IRS office to see if they have one.

Start­ing a busi­ness. It is entirely pos­si­ble for you to start a busi­ness after you have been laid off.  Noth­ing stops you from being an employee and a busi­ness owner in the same year; indeed if you form a cor­po­ra­tion you maybe an employee of your cor­po­ra­tion and a busi­ness owner at the same time.

There are three basic types of busi­nesses: Sole proprietor-an unin­cor­po­rated busi­ness started by one per­son, a partnership-an unin­cor­po­rated busi­ness started by 2 or more peo­ple, or a cor­po­ra­tion.  Lim­ited Lia­bil­ity com­pa­nies are not rec­og­nized by the IRS for tax pur­poses so it will default, or elect to be treated as one of these other basic entity types.  The deci­sion as to what type of busi­ness to start involves risk fac­tors, record keep­ing require­ments and other issues that are beyond the scope of this discussion.

Gen­er­ally all busi­nesses need to keep records reflect­ing the income received by the busi­ness and the expenses relat­ing to pro­duc­ing that income.  Finan­cial state­ments, bank records, receipts, bills, etc.  all should be kept as well.  How to keep records and what records to keep are beyond the scope of this discussion.

Busi­ness income is reported on a Sched­ule C (sole pro­pri­etor), Sched­ule E (rental real-estate and roy­alty income), Sched­ule F (farm income), Form 1065 (part­ner­ship income), Form 1120S (S-corporation Income), or Form 1120 (C-Corporation income).   All busi­ness own­ers have to pay 15.3% self-employment taxes in addi­tion to reg­u­lar income taxes.  If a busi­ness has employ­ees the own­ers have to pay employ­ment taxes (employer por­tion of social secu­rity & Medicare, state and fed­eral unem­ploy­ment etc) on their employ­ees as well.  In addi­tion to self-employment taxes busi­ness own­ers have to pay esti­mated income taxes on their busi­ness income as well.  Exactly which forms to file and when is beyond the scope of this discussion.

Sole pro­pri­etors may be eli­gi­ble for the earned income credit.  Self-employed peo­ple may also qual­ify for adjust­ment so income for pro­vid­ing their own health insur­ance and set­ting up retire­ment accounts for their busi­ness.  The details are beyond the scope of this discussion.

Expenses of look­ing for a job. If you item­ize you deduc­tions on your tax return (file a sched­ule A with your 1040) you may be able to deduct some of the expenses of look­ing for a new job.  Expenses such as resume prepa­ra­tion, out place­ment agency fees, costs of mail­ing your resume, cer­tain expenses for travel overnight more than 50 miles from your home to look for work (if it pri­mar­ily for this pur­pose and not for per­sonal plea­sure) may be deductible.  The deduc­tions are lim­ited by the 2% lim­i­ta­tion of income; for exam­ple, if you made $20,000 then only the total mis­cel­la­neous expenses that exceed $400 will be deductible and only if you item­ize your deductions.

Edu­ca­tional expenses. Some peo­ple may ben­e­fit from pick­ing up a lit­tle edu­ca­tion while look­ing for a new job.  You may qual­ify for the Hope or Life­time Learn­ing credit.  Some­times tuition costs may deductible as employee busi­ness expenses sub­ject to the 2 % lim­i­ta­tion of income on 1040 sched­ule A. To qual­ify as an employee busi­ness expense the edu­ca­tion must relate to your cur­rent work and it can­not pre­pare you for a dif­fer­ent job, or higher level job; edu­ca­tion that takes an LPN to an RN or a tech­ni­cian to an engi­neer, or that makes a doc­tor a lawyer, etc. is not con­sid­ered work-related edu­ca­tion although this edu­ca­tion may qual­ify for the Hope or Life­time Learn­ing credit.

Mov­ing Expenses. Cer­tain expenses relat­ing to mov­ing to obtain a new job are deductible, gen­er­ally the move has to be closely related in time to start­ing the new job and you must have moved at least 50 miles.

Sell­ing your home. If you sell your home, whether it is vol­un­tar­ily or because you have to move to obtain new work, and if you have owned and lived in your main home for at least 2 of the last 5 years, you may be able to exclude gain of up to $250,000 ($500,000 Mar­ried fil­ing Jointly).   If you are fore­closed on in between 2007 and 2012, the fore­clo­sure is directly related to a decline in your home’s value or your finan­cial con­di­tion, and your debt is for­given, you may debt for­give­ness income that may also be excluded from your income.

If you need help, Please give Art & Busi­ness Con­sult­ing a call. We would love to engage you as a client.

The usual dis­claimers: Although ABC has made every effort to insure the accu­racy of Taxes, Tips and Tools, mis­in­for­ma­tion, dis­in­for­ma­tion, changes, mis­takes, typos and hack­ers hap­pen, there­fore Art & Busi­ness Con­sult­ing LLC takes no respon­si­bil­ity for any action taken or results based on the infor­ma­tion sup­plied here in.   Inter­nal Rev­enue Ser­vice Cir­cu­lar 230 Dis­clo­sure:  As pro­vided for in Trea­sury reg­u­la­tions, advice (if any) relat­ing to fed­eral taxes that is con­tained in this com­mu­ni­ca­tion (includ­ing attach­ments) is not intended or writ­ten to be used, and can­not be used for the pur­pose of (1) avoid­ing penal­ties under the Inter­nal Rev­enue Code or (2) pro­mot­ing, mar­ket­ing or rec­om­mend­ing to another party any plan or arrange­ment address herein.  Art & Busi­ness Con­sult­ing LLC cur­rently does not have a cer­ti­fied pub­lic accoun­tant or an attor­ney on staff; this infor­ma­tion is purely for edu­ca­tional pur­poses and not to be con­strued as legal or finan­cial advice. Art & Busi­ness Con­sult­ing LLC and its employ­ees, mem­bers and asso­ciates are not engage to prac­tice law; you always should dis­cuss legal mat­ters with your attor­ney before talk­ing to any­one else.