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.
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