Being unemployed is challenging enough, taxes are probably the last thing on your mind when you’re out of work. If you receive unemployment pay, you will have to pay taxes on the money you receive as income. In some situations, though, federal tax laws can help reduce some of the financial difficulties of unemployment with tax breaks.
Here are some of the more common tax breaks, deductions, and considerations you’ll need to review when filing taxes during a year that you were unemployed:
If you didn’t qualify for the Earned Income Credit in the past, now that you are unemployed, it’s possible the reduction in your earnings will make you eligible for this tax credit. The EITC is available to individuals who don’t make a lot of money. You don’t have to calculate unemployment benefits when figuring if you qualify for the Earned Income Credit. This particular tax credit is refundable, so if you don’t owe any taxes at all, you’ll get a refund in the amount of Earned Income Credit you are entitled to. The credit is easier to qualify for if you have children, but individuals without children may qualify, with lower income amounts.
If you’re actively looking for a new job, expenses related to employment agency fees, resume creation and job-hunting travel are tax deductible. Your job hunting expenses must be more than 2% of your adjusted gross income in order to qualify for the deduction, and you must itemize your tax return. Only job hunting expenses for employment within your same industry will qualify; you can’t deduct expenses when you are looking for a job in a different industry.
Unemployment income is considered normal gross income and is reported on Form 1040, 1040A or 1040EZ. It includes both unemployment compensation received by the United States government or through your state. You should receive a 1099-G Form that indicates the amount of unemployment income you receive, which you use to calculate the amount of taxes you owe on the income. It’s a good idea to set aside a percentage of every unemployment benefit check you receive to use when taxes are due.
Many people decide to cash in their retirement accounts early when they’re unemployed for access to money. This is generally not a good idea, as you will have to pay a 10% penalty if you’re under the age of 59 ½ for traditional IRAs or under the age of 55 for a 401(k), as well as pay taxes on the money you take out.
If you are paying for medical expenses that are not reimbursed and that are more than 7.5% of your income with money withdrawn from a retirement account, you do not have to pay a penalty.
If you’re unemployed for 12 weeks consecutively, you can take money from an IRA without penalty to pay for medical insurance.
There are instances when you can take a hardship withdrawal from an employer-sponsored retirement plan (like a 401k) if it qualifies as an immediate financial need for medical expenses, educational expenses, or to prevent foreclosure of your home or eviction from a rental property.
Even if you have a qualifying situation to avoid the 10% early distribution penalty, you will still have to pay income taxes on the money you withdraw from retirement accounts, so make sure to weigh this decision carefully.
This post was published on June 2, 2011