Tax Edge

By Robert Steere, Toolkit Staff Writer

The challenge of job loss has grown to near epidemic proportions in 2009. Current statistics show that 15.7 million people were unemployed at the end of October, and that, on average, approximately 500,000 have been added to the unemployment rolls in every month during 2009. We all know people facing the challenge and uncertainty of job loss, and many of us have faced it ourselves.

If you are not alert to the tax considerations that come into play when job loss occurs, you may add a tax headache to the heartache of unemployment. There are things you should know to help you through the period after losing a job. Pay attention to these issues, and at least you can keep your tax headaches to a minimum.

Severance payments and PTO payouts. Remember that, if you receive any form of severance payments or payments for accumulated sick leave, vacation or personal time off, all of these payments are wages and salary subject to withholding by your employer and includible in your taxable income in the year they are paid. It doesn't matter that you are no longer working when you receive the payments.

Unemployment compensation. If you apply for and receive unemployment benefits from your state employment security agency, be aware that these benefits are generally included in your taxable income for the year in which they are received. However, for 2009 only, you can exclude from taxable income up to $2,400 of unemployment benefits. This results from special legislation enacted during the year. Any amounts you receive in excess of $2,400 during 2009 are included in taxable income.

COBRA health insurance subsidy. If you had employer-provided health insurance before losing your job, you may have elected to continue your health insurance coverage under COBRA by paying the full monthly premiums for the continuing coverage. As a result of special legislation in 2009, you may have received a federal government subsidy of 65 percent of the cost for as many as nine months of the coverage. This subsidy for COBRA premiums is excluded from your taxable income. You do not have to report it on your income tax return.

Retirement distributions. You may consider withdrawing some of your retirement funds from a qualified employer-provided retirement plan upon ending your employment. Generally speaking, if you withdraw funds before you reach age 59, and you don't roll over the funds into another qualified plan or IRA within 60 days, the amount withdrawn is included in your taxable income in the year it is received. Not only that, but it will be subject to an additional 10 percent penalty tax for early withdrawal. Unless you truly need the funds during the time immediately after job loss, it is better to transfer retirement funds directly into an IRA to avoid the taxes. The same taxes apply if you withdraw funds from an IRA before retirement age. Some hardship exceptions may apply. Be aware that you pay a price in higher taxes if you withdraw funds early from an IRA in order to meet your immediate financial needs.

Other items excluded from taxable income. If you are eligible for and receive public assistance or food stamps, the value of these benefits is not taxable. Neither are gifts that you may receive from family or friends to help support you and your family while you are unemployed. If you need to sell your home in which you have lived for at least two years, you can usually exclude a gain of up to $250,000 ($500,000 if married filing jointly) on the sale.

Looking for new work. Some of the expenses you incur while looking for new employment may be deductible. Employment and outplacement agency fees, expenditures for typing, printing and mailing applications and resumes, and travel expenses related to job hunting and interviews are generally deductible if you are looking for work in your current occupation. Moving expenses in order to be located near your new job may be deductible, assuming you have to move at least 50 miles to your new job location. If you invest in more college training to improve your chances of a new job, you may be eligible for education tax credits or a deduction for tuition and fees.

Starting a small business. You may respond to your job loss by starting a new small business instead of looking for new employment. If so, you will have a whole new set of tax issues to take into account. You may want to seek professional assistance. You'll have options regarding setting up the business as a proprietorship, a corporation or an LLC. You may need to obtain a new employer identification number for the business and prepare to handle payroll withholding if your business will have employees. You may have to begin paying estimated taxes for yourself, because you won't have an employer to withhold taxes for you.

These are just a handful of the tax issues that you may be facing if you have suffered job loss in 2009. Don't let potential tax headaches get the best of you. Be alert to them, and address them as they arise. The IRS provides all kinds of information that can help you address these issues. For more information, go to the IRS web site.

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Posted December 11, 2009.