Monday, April 13, 2009

Making the Most of Your Taxes for the Growing Legions of Unemployed – Part 1

Millions of people are facing unemployment as a very real possibility. Sacramento’s unemployment rate recently grew to over 10%, with no signs of slowing. With so many people out of work and desperately trying to make ends meet, this is the perfect the time to figure out the impact unemployment has on your taxes.

State and federal unemployment compensation is taxable income. This comes as a surprise to many, but taxes are not always automatically withheld from funds received under state or federal unemployment compensations laws. If you received unemployment pay during the year, you should receive a 1099-G showing the amount you were paid, and if any taxes were withheld. (NOTE: if you receive unemployment compensation during 2009, the first $2,400 is tax free. Not much help when filing your 2008 taxes, of course but good news for next year.)

If you lost your job in 2008 and received a severance package, those funds are also subject to income tax. Any severance pay, including cashing out your accumulated vacation or sick pay, is considered ordinary income. Some larger severance packages can even bump you into a higher tax bracket!

Many people use their time unemployed to do some freelance work. This can be a great way to bring in some funds, however, anything earned is considered self-employment income. Which means you are responsible for not just income tax, but also self-employment tax (15.3% of your net profit, representing the Social Security and Medicare taxes owed from your business profit).

  • If your freelance work earned you more than $400, you are required to file a tax return, including a Schedule C detailing income and expenses for the year.
  • If you earned more than $600 on one project, expect to receive tax form 1099, and you must include that as taxable income. (If you did not earn over $600 on a project, you will not receive a 1099, but you still have to include any income on your tax return.)
If you withdrew funds from a qualified retirement plan or IRA to help make ends meet during your unemployment, then you must report it as taxable income, and large amounts might put you in a higher tax bracket. Withdrawing funds before you are eligible for retirement can really throw a wrench in you taxes, as it can be heavily penalized sometimes with an additional 10% tax on top of normal income tax rates.

However, if you withdrew funds to roll over into another qualified retirement account or IRA within 60 days, those funds are not taxable income.

As with every life changing event, there are tax implications to unemployment. The best way to ensure you are getting the most out of the situation—and not tripped up—is to get educated! By increasing your tax knowledge and remaining vigilant with your tax planning, you can save yourself a world of hassle and a lot of money.

Part 2 of this topic will be coming soon, discussing the ways you can make the most of your taxes when you are unemployed.

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