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Also, the 2009 CCH provides special CCH Tax Briefings on key topics at: CCHGroup.com/Legislation/Briefings.
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CCH Outlines the Tax Implications of Being Out of WorkPaying Taxes on Unemployment Benefits, Tapping Retirement Plans, Health Insurance Deductions, Tax Relief for Job Seekers(RIVERWOODS, ILL., January 2009) – Unemployment rates spiked in 2008 and lawmakers reacted by extending federal unemployment benefits twice during the year; however, what the federal government gives, it also can take a piece of in the form of income taxes come April 15, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com). The mildly good news for some out-of-work taxpayers is that benefits have been extended. Generally, states provide approximately 26 weeks of unemployment benefits to eligible displaced workers. In the summer of 2008, the Emergency Unemployment Compensation Act was signed into law, providing an added 13 weeks of federal unemployment. In November, the Unemployment Compensation Extension Act of 2008 added seven weeks of emergency unemployment benefits and established a second tier of 13 weeks of benefits for individuals in states with high unemployment rates. “Ensuring you are minimizing your tax obligation as much as possible is all the more important for someone out of work,” said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA. According to Luscombe, it’s important to understand what taxes you may owe on your income as well as understand the tax options and tax penalties for everyday issues you may face during unemployment. Examples include whether to tap retirement accounts, how to deal with health insurance costs and the costs of searching for a job, as well as the consequences of taking part-time work to starting your own business. Below, CCH examines each. Understanding Your Income Tax LiabilityWhen you receive unemployment benefits, you are responsible for paying the taxes on those benefits, based on your overall income. For those who lost good-paying jobs late last year, it could mean that despite being out of work, you are still in the same tax bracket as you’d been in when employed. “If you had an annual salary of $120,000 and were laid off during the fourth quarter of 2008, after receiving $90,000 of that salary, there’s a good chance you’ll still be in the 28-percent tax bracket as a single filer, assuming your taxable income is above $78,850,” Luscombe said. “Moreover, any unemployment benefits you receive will be taxed at that 28-percent rate. It may not seem fair, given that you’re not working, but the income tax rate is based not on what you earned but on your total income, whether from salary or unemployment benefits.” Those who have been unemployed for a longer period likely will be in a lower tax bracket. But they, too, are required to report all income and pay taxes based on their overall income level. For example, say you live in Michigan and had an annual salary of $84,000 when you lost your job at the beginning of January 2008. You had severance until March 1, at which time you went on unemployment. So, from your income while you were employed and your severance pay, you earned $14,000 during the first two months of the year. You went on unemployment for the rest of the year – or 44 weeks – using all your state unemployment benefits as well as the full 13 weeks of temporary extended unemployment offered under the federally-funded Emergency Unemployment Compensation Act and several weeks of emergency unemployment benefits under the Unemployment Compensation Extension Act. Your unemployment benefits through December 31, 2008, were $362 a week (the maximum allowed in Michigan) for the 44 weeks, or $15,928 for the year. As a result, your income in former wages and unemployment benefits totaled $29,928 for the year. For the first two months of the year, while you were employed or receiving severance, your employer withheld for income tax as well as for FICA (Federal Insurance Contributions Act) tax. Once you began collecting unemployment, you no longer have to pay FICA, but you do have to pay income tax. In the above example, assuming you’re single with no dependents, this is the only income you earned and you were entitled to a standard deduction of $5,450 for 2008 as well as one exemption of $3,500; you moved from the 25-percent tax bracket to the 15-percent bracket. As a result, you could still owe taxes on your income, depending upon how much your former employer withheld and how you’ve handled withholdings on your unemployment benefits for the remainder of the year. When you first begin receiving unemployment benefits, your state should inform you of this and give you the option to have the state withhold from your benefits for both state and federal income tax. If you do not take your state up on the withholding option, you are required to figure out what you owe and file quarterly estimated taxes with the IRS and your state treasury department. If you do not, you may be subject to a late payment penalty as well the outstanding taxes. Health Care and TaxesOne of the largest new costs for unemployed individuals can be paying the health care premium previously covered, at least in part, by your employer. Most employees who are laid off can continue health care coverage through their former employer’s group health care plan for up to 18 months under COBRA (Consolidated Omnibus Budget Reconciliation Act of 1985). Footing the entire bill for health care insurance as well as an additional 2-percent administrative fee your former employer can tack on to COBRA may seem steep. However, enrolling in COBRA may be the best option if you have no other alternatives, such as gaining coverage under your spouse’s insurance plan, as individual health insurance is generally even more costly than COBRA. Although your former employer was able to deduct the amount he or she paid for your health insurance, employees and former employees are not generally allowed to deduct the cost of health insurance. However, individuals can deduct medical expenses (which include health insurance) if you choose to itemize and these costs exceed 7.5 percent of your adjusted gross income (AGI). “If you’re unemployed, you’re earning less, so your medical costs may very well exceed the 7.5 percent threshold,” said Luscombe. “For example, if your AGI was $28,000, you’d only need $2,100 in medical expenses, including what you pay in health insurance premiums, to reach that level. All medical expenses beyond that $2,100 would then be tax deductible, as long as you itemized.” Individuals may also be able to tap into your IRA to cover health insurance premiums while they are unemployed and meet certain qualifications. These qualifications include the following: the withdrawals must not exceed the amount paid during the year for medical insurance for the taxpayer, his spouse and dependents; the taxpayer must have received unemployment compensation for 12 consecutive weeks under federal or state law; and the distribution must be made during any tax year in which the taxpayer receives unemployment compensation or during the next tax year. Note that this option is not available to 401(k) plan participants, nor may 401(k) plan participants use contributions held in individual accounts to pay premiums for long-term care insurance. A 401(k) plan participant may not access funds (without incurring penalty tax) prior to retirement unless specified statutory exceptions, (discussed below) apply. Avoiding Tax Penalties for Tapping into Retirement AccountsUnderstanding what options you have for your retirement plan after losing your job are essential in making sure you’re not chipping away further at your retirement savings through penalties and taxes. When you leave your employer, you generally have three options for addressing any retirement plan you have with your former employer. You can choose to keep the existing plan, assuming you meet the requirements to do so; request a direct rollover to another plan; or cash out of the plan altogether. Each option has its own set of tax consequences. You may elect to cash out the account balance, which will provide you with immediate access to needed funds. However, you will be subject to income tax and possible penalty tax on the distribution. In addition, if you are married, your ability to cash out an account will be subject to spousal consent. Additionally, some plans do not authorize a lump-sum cash out distribution of an account over $5,000. The plan may, instead, pay out the funds as an annuity. If the value of your account in a 401(k) or other qualified plan with your former employer is valued at more than $5,000, you can leave the funds in the plan. The account will continue to grow tax-deferred even though you will no longer be making contributions to the plan. However, maintaining funds in an account may not mean you have all of the options or rights available under the plan to current employees. For example, plans are not required to provide for loans to former employees. Most employers, in fact, do not authorize this option, primarily because of the administrative difficulty of ensuring repayment from an individual they no longer employ and, thus, are not able to ensure repayments through salary reduction. In the event your plan does provide for loans to former employees, you need to be aware that the funds must be repaid within a specified period. A default on the loan will subject you to significant tax consequences. As an alternative to loans, you may wish to consider other options that may be available under the plan. For example, some plans offer penalty-free hardship distributions. Hardship distributions are authorized for the payment of medical expenses, costs associated with avoiding foreclosure and other specified events. However, the distribution is limited to the amount necessary to alleviate the hardship and is subject to penalty tax. The bottom line is you should check the terms of the plan first, as options that may be available to current employees may not be afforded to former employees. If you have less than $5,000 in the plan or simply want to move out of your former employer’s plan into another qualified plan, you are allowed to take the funds and roll them over into another tax-deferred plan. You can do the rollover yourself, in which case your employer will send you a check for the balance less a 20-percent withholding for income taxes. Once you receive the check, you have 60 days to deposit it into a qualified tax-deferred plan. If you do this, you’ll get your 20-percent withholding back; if not, the IRS gets it. The safer approach, if you want to move the money, is to request a direct rollover to an eligible tax-deferred account. Then, your account will be rolled over in its entirety to the new account without any withholding. Any 401(k) plans that provide for the mandatory cash-out distribution of an account balance that does not exceed $5,000 must use a direct rollover as the default option for involuntary distributions over $1,000. Thus, employers may not cash out a participant whose account balance is $5,000 or less but over $1,000. The distribution must be automatically rolled over to a designated IRA, unless the participant elects to have the distribution transferred to a different IRA or to receive it directly. Regardless of the scenario, if the 401(k) is rolled over into an IRA or another 401(k) plan directly or within the 60 days, there are no tax obligations or penalties and your retirement savings can continue to grow, tax-deferred, in the new plan. However, if you rolled the funds over to an IRA and you later decide you need to tap into your retirement to tide you over, you have far fewer options than provided by a 401(k) plan. For example, a 401(k) plan may allow you to take loans for a number of unspecified reasons. Penalty-free withdrawals from an IRA, however, are limited to just a few specific purposes, including health insurance premiums, “qualified” higher education expenses or “first-time homebuyer” expenses. (See Release 12 for additional detail on the tax consequences of tapping into a 401(k) account.) Costs of Searching for a Job Are DeductibleThe longer someone is out of work, the more the job search is likely to cost. So keeping track of expenses and taking the eligible deductions can provide welcome tax savings. Among deductible expenses are resume printing costs, postage, long-distance calls and faxes; travel expenses, including air, taxi and rail, as well as mileage and tolls; and lodging expenses for out-of-town interviews. However, you can only claim the expenses if you are seeking a position in the same trade or business. Once you find a job, if you have to move to be closer to work, the moving expenses may be tax deductible as well. For the move to be tax deductible the new principal place of work must be at least 50 miles farther from your old residence than the old residence was from your former place of work. So, for example, say you lived in Bridgeport, Conn., and worked just two miles from your home before being laid off. You subsequently found a new job in New York City, which is 55 miles from your home. As a result, your new place of work is 53 miles farther from your home than your old job was and your moving expenses to a new home, assumingly closer to your new job (though not a requirement under tax law), would be tax deductible. However, any costs reimbursed by your new employer would not also be tax deductible to you. Part-time Work or Becoming Self-employed Have Tax Benefits and LiabilitiesThose who are unemployed and decide to do some consulting or find part-time work to help supplement income while they look for another job need to be cautious of the tax consequences, as well as the risk these situations can pose to unemployment benefits. If you decide to take a part-time job, you need to be aware of how much income you can make from working before your unemployment benefits are reduced or eliminated. If you opt to be your own boss and take on some consulting work temporarily, for example, you are officially considered self-employed. This means you are required not only to pay income tax but you also must pay into Social Security and Medicare under the Self-Employment Contributions Act (SECA) if you made more than $400 in income while self-employed. This tax is basically the self-employed individual’s version of FICA. As an employee, your FICA tax was only 7.65 percent with your employer paying another 7.65 percent. As a self-employed individual, you are now required to pay the entire 15.3-percent SECA tax. Whatever type of temporary work you consider, you have to be very aware of your state’s unemployment benefit laws and be willing to do the math – or risk losing your benefits. For example, if your consulting is slightly more successful than you thought or you didn’t keep track of what you were bringing in from your part-time job, you could significantly reduce or make yourself entirely ineligible for unemployment benefits. You can’t then stop consulting or quit your part-time job and become eligible again for the same unemployment benefits you had been collecting. For example, if you took a part-time job, your future unemployment benefits would be based on your part-time wages. If you’d been consulting, once you exceeded the allowable wages from self-employment, you would no longer be eligible for any unemployment benefits even if you stopped working completely. However, if you are seriously thinking of making a go of being self-employed, there are some added tax benefits you may be eligible for. For instance, among deductions are 100 percent of health insurance costs; costs of installing and using a second phone line if working from a home office; journals; dues for unions or professional associations; advertising and marketing expenses; gifts valued up to $25 to business associates, postage; business-related legal and professional services; and business travel expenses. Additionally, you can take depreciation on office equipment and may be eligible for certain small business credits. About CCH, a Wolters Kluwer businessCCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. Among its market-leading products are The ProSystem fx® Office, CorpSystem®, CCH® TeamMate, CCH® Tax Research NetWork™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. The company provides products and services globally for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory sectors. Wolters Kluwer has annual revenues (2007) of €3.4 billion ($4.8 billion), maintains operations in over 33 countries across Europe, North America and Asia Pacific and employs approximately 19,500 people worldwide. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. For more information, visit www.wolterskluwer.com. --### -- nb-09-22
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