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2010 CCH Whole Ball of Tax
Tax Rules Eased for Unemployed But Not Erased, CCH Says
Unemployment Benefits, Health Care, Retirement Accounts, Job Search and Temporary Work Have Tax Consequences
(RIVERWOODS, ILL., January 2010) – With unemployment climbing to rates not seen in more than 25 years, changes were made to the tax code in 2009 to provide breaks for people out of work, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com). However, the unemployed still face income tax issues and it’s important they clearly understand these so that they are not paying too much or too little in taxes, or making other moves that could trigger additional taxes and penalties.
“Being out of work is unfamiliar territory for most people,” said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA. “When money is tight and resources are limited, it’s particularly important to understand your tax obligations.”
Issues with potential tax ramifications for the unemployed include the taxability of unemployment benefits, health care benefits, retirement accounts, job searches and temporary work. Below, CCH examines each.
Tax Implications of Unemployment Benefits
Recognizing the long-term severity of the recession, unemployment benefits were extended as part of The Worker, Homeownership, and Business Assistance Act of 2009. Under this law, unemployment benefits were extended 14 weeks nationally with an additional 6 weeks in states with unemployment rates over 8.5 percent. This is in addition to the 26 weeks of unemployment benefits generally offered by most states.
Earlier in 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) also provided a tax break for people who were out of work. Under this law, they can exclude up to $2,400 of unemployment compensation from their 2009 gross income.
However, with the exception of the first $2,400, the remaining unemployment benefits are taxable for 2009. Additionally, just as they had done with their paychecks, unemployment benefit recipients are expected to have taxes withheld from their unemployment benefit checks throughout the year or to file quarterly estimated taxes based on their income.
The state should inform the unemployed worker of this and give them the option to have the state withhold from their benefit for both state and federal income tax. Beneficiaries choosing not to have their state withhold the taxes must file quarterly estimated taxes with the IRS and their state treasury department. If they don’t, they may be subject to a late payment penalty as well the outstanding taxes.
“People who did not have their withholding adjusted as a result of the $2,400 exemption may end up getting a better-than-expected refund,” said Luscombe. “However, those who failed to have the state withhold from their benefit checks and failed to file estimated taxes may find they owe both taxes and interest.”
The $2,400 exclusion is only available for 2009. For 2010, all unemployment benefits will again be subject to income tax.
Health Care and Taxes
Paying the health care premium previously covered, at least in part, by their employer, as well as covering medical expenses are significant costs for people out of work. And, both have tax consequences.
Most employees who are laid off can continue health care insurance coverage through their former employer’s group health care plan under COBRA. However, the cost – which included paying the full health care insurance premium as well as up to a 2-percent administrative fee – made this option out of reach for many of those out of work.
Another provision of ARRA attempted to temporarily ease this burden. Applying retroactively from September 1, 2008 to January 1, 2010, the law allows people who were laid off to elect to pay just 35 percent of their COBRA coverage with their former employer picking up the remaining 65 percent of the cost (but subsequently being reimbursed by crediting those amounts against and payroll tax withholdings). While COBRA coverage is available to most individuals for up to 18 months after losing their job, the premium subsidy is only available for nine of those months.
This premium subsidy could be extended through proposed legislation now being considered.
While employers are allowed to deduct health insurance costs they pay for employees, individuals – whether out of work or working – are generally not allowed a tax deduction for health insurance costs. The exception is if their medical expenses exceed 7.5 percent of their adjusted gross income (AGI). In these instances, they can deduct the costs of medical expenses, which include health insurance costs, in excess of 7.5 percent of AGI if they itemize.
“Fewer unemployed may be able to deduct medical expenses if they are only paying 35 percent of their health insurance premium cost,” said Luscombe. “However, the benefit of a lower premium cost likely outweighs the benefit of the medical expense deduction.”
Other ways unemployed workers can help ease the cost of paying for health insurance include tapping their IRA or, for some, taking the Health Care Tax Credit (HCTC).
Individuals can tap their IRA, without penalty, 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 or her 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.
Accessing 401(k) retirement funds to cover health insurance premiums would be considered an unqualified distribution and trigger a 10-percent penalty as well as additional tax implications.
Another health-care related tax break included in ARRA was expansion of the HCTC. This now pays 80 percent of the qualified health insurance premium for eligible individuals, up from 65 percent previously. Among individuals eligible for HCTC are workers who lost their job because of foreign competition. These are individuals receiving Trade Readjustment Allowances under the Trade Adjustment Assistance program and similar programs.
Holding on to Retirement Accounts
People uncertain of how to manage their retirement plans after losing a job can easily make mistakes that trigger additional taxes and penalties, in addition to reducing the value of their retirement funds. When an employee leaves a job, they generally have the following options:
- Keep the funds in the former employer’s 401(k) plan . If the person’s 401(k) or other qualified plan is valued at more than $5,000, they can leave the funds in the plan. The account will continue to grow tax-deferred. However, as a former employee they will not be allowed to make plan contributions and may not have other rights available under the plan that are afforded to current employees, such as taking plan loans. Hardship distributions would still be available; however, these distributions generally have very strict requirements and are subject to both income tax as well as a 10-percent penalty tax.
- Roll the funds over to an IRA or other qualified plan . Individuals who want greater control over their retirement funds can request their former employer directly roll over funds to an eligible tax-deferred account, such as an IRA. However, an IRA typically does not offer as many penalty-free borrowing options as most 401(k) plans. For example, a 401(k) plan may allow a person to take loans for a number of unspecified reasons, while penalty-free withdrawals from an IRA are limited to just a few specific purposes, including health insurance premiums, “qualified” higher education expenses or “first-time homebuyer” expenses. Direct rollover of funds is required for any plan that has a mandatory cash-out distribution of accounts with balances from $1,000 to $5,000.
Individuals also can choose to take direct possession of the funds and roll over on their own into another tax-deferred plan. However, a significant disadvantage of doing a rollover on their own is that 20 percent of the funds will be withheld. They have 60 days in which to deposit the entire amount – including coming up with the equivalent of the 20 percent withheld – into a qualified tax-deferred plan. If they do so, they will get the 20-percent withholding back. Otherwise, it will be considered a cash-out distribution subject to the same taxes and penalties as below.
- Cash-out the retirement plan . Individuals also can elect to cash-out their retirement plan altogether. In addition to paying income tax on the cashed-out funds, they also will be subject to a 10-percent additional tax unless they are over age 59½ or meet other early distribution allowances.
There are two notable exceptions to the 10-percent penalty, however, for people who are unemployed. A person who was laid off, quit or took early retirement in the same year they turned 55 or later may be able to take a penalty-free distribution; or establish a payment schedule of regular equal withdrawals over their lifetime or the joint lives of the participant and the beneficiary.
Generally, the greater the value of the individual’s account is, the more options are available to them. Accounts valued at more than $5,000 can generally be maintained in a former employer’s plan. Accounts valued between $1,000 and $5,000 where the plan has a mandatory cash-out distribution must be directly rolled over into another qualified plan. Plans can automatically cash out accounts below $1,000.
“Before making a decision about what to do with retirement plans in light of being out of work, people should understand what their needs are likely to be while out of work and what the various restrictions and terms are to the retirement plan,” said Luscombe. (See Release 13 for additional detail on the tax consequences employees face when tapping their 401(k) accounts.)
Job-search Tax Deductions
Finding a job costs money but much of this is tax deductible. Deductible expenses include 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, the expenses can only be claimed if the person is seeking a position in the same trade or business.
Moving expenses can also be tax deductible. To qualify for the deduction, the new workplace must be at least 50 miles farther from the employee’s old residence than the old residence was from their former workplace.
So, for example, say someone lived in San Francisco, and worked just three miles from their home before being laid off. They take a new job in San Jose, which is 58 miles from their home and 55 miles farther from their home than their old job was. As a result, moving expenses to a new home, presumably closer to the new job (though not a requirement under tax law), would be tax deductible. Any costs reimbursed by the new employer, however, would not be tax deductible to the new employee.
Tax Consequences of Temporary Work
People taking on temporary work between jobs need to be cautious of the tax consequences, as well as the risk these situations can pose to unemployment benefits. Unemployment benefits are reduced or eliminated once a person makes a certain income. This amount is set by each state’s unemployment benefit laws and is generally low.
Additionally, individuals doing consulting work, even temporarily, are officially considered self-employed. This means they are required to pay both income tax as well as to pay into Social Security and Medicare under the Self-Employment Contributions Act (SECA) if they made more than $400 in income while self-employed. This tax is the self-employed individual’s version of FICA, but more costly to the individual. An employee’s FICA tax is only 7.65 percent with their employer paying another 7.65 percent. However, someone who is self-employed is required to pay the entire 15.3-percent SECA tax.
Whether as a temporary employee or temporarily self-employed, people collecting unemployment benefits that exceed their state’s allowable income can’t then quit their temporary work and become eligible again for the same unemployment benefits they had been collecting. Rather, temporary workers’ future unemployment benefits would be based on the wages they were paid for their temporary work. Self-employed people, who exceeded the allowable wages from self-employment, would no longer be eligible for any unemployment benefits even if they stopped working completely.
While there are additional tax reporting requirements, such as quarterly estimated taxes, and additional taxes such as SECA, individuals choosing to become self-employed may realize some tax benefits. 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, they can take depreciation on office equipment and may be eligible for certain small business credits.
About CCH, a Wolters Kluwer business
CCH, 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. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands (www.wolterskluwer.com).
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