CCH can assist you with stories, including interviews with CCH subject experts. Also, the 2011
CCH Whole Ball of Tax is available in print. Please contact:
 
Leslie Bonacum
(847) 267-7153
mediahelp@cch.com
 
Eric Scott
(847) 267-2179
eric.scott@wolterskluwer.com

Visit the CCH Whole Ball of Tax site often as new releases and other updates will be posted throughout the tax season.

CCH provides special CCH Tax Briefings on key topics at CCHGroup.com/Legislation.

• CCH Tax Briefing: 2012 Federal Budget Proposals
• CCH Tax Briefing: 2010 Tax Year-in-Review
• CCH Tax Briefing: 2010 Tax Relief/Job Creation Act
• CCH Tax Briefing: Sunsetting Benefits of the Economic Growth and Tax Relief Reconciliation Act of 2001
• CCH Tax Briefing: Small Business Jobs Act of 2010 (H.R. 5297)
• CCH Tax Briefing: Education/Jobs/Medicaid Assistance Act of 2010
• CCH Tax Briefing: Homebuyer Assistance and Improvement Act of 2010
• CCH Tax Briefing: Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010
• CCH Tax Briefing: Health Care Reform Act
• CCH Tax Briefing: 2010 Hiring Incentives to Restore Employment Act

The Tax Implications of Being Out of Work: Unemployment, Health Care, Retirement Accounts, Job Search and Temporary Work Have Tax Consequences  

(RIVERWOODS, ILL., January 2011) – With unemployment rates continuing to remain high throughout 2010, millions more people are facing a tax season where they need to understand the tax consequences of being unemployed, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).

Since the unemployed still face income tax issues, it’s important they clearly understand these issues so that they are not paying too much or too little in taxes, or making other moves that could trigger additional taxes and penalties.

“You can’t assume that because you aren’t earning income from work, that you don’t have tax obligations,” said CCH Principal Federal Tax Analyst Mark Luscombe, JD, LLM, CPA. “However, while you may have some taxes to report, you may also have deductions that can help reduce or eliminate your taxes.”

Issues with potential tax ramifications for the unemployed include the taxability of:

• Unemployment benefits;
• Health care benefits;
• Retirement savings; and
• Job search and temporary work.

Below, CCH reviews the tax implications of each.  

Unemployment Benefits

As part of the end-of-year Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act), unemployment benefits were extended by 13 months for those who only received six months of state benefits. Proponents of the new law estimated that as many as seven million people would have lost assistance within the next year without this further extension.

While unemployment benefits have been extended, they are fully taxable for 2010, unlike 2009 when there was a one-time $2,400 exemption on benefits.

Additionally, people receiving unemployment benefits are expected to have both state and federal taxes withheld from their unemployment benefit checks, just like they did with their paychecks. The state informs beneficiaries of this option and does the withholding.

Alternatively, beneficiaries choosing not to have taxes withheld from their unemployment income are required to file quarterly estimated taxes with the IRS and their state treasury department. Failure to pay taxes through withholding or estimated taxes may subject them to a late payment penalty as well as the outstanding taxes.

“It can be difficult for people who were already attempting to get by on unemployment benefits to find out the limited amount can be further reduced not only by taxes but penalties,” said Luscombe.

While the unemployed may have to pay taxes on their benefits, employers who hired unemployed workers in 2010 may be able to realize certain tax breaks through the Hiring Incentives to Restore Employment (HIRE) Act. Two key benefits of the HIRE Act for employers hiring unemployed workers include:

• Employer payroll tax exemption: Employers received an exemption from the employer’s 6.2-percent share of Social Security tax on all wages paid to each qualified employee from March 19 through December 31, 2010. Qualified employees were those hired after February 3, 2010 and before January 1, 2011 who were previously unemployed or employed for 40 hours or less for the previous 60 days. Congress did not extend this incentive for 2011.

• Retained worker business credit: Additionally, employers retaining these workers for at least 52 consecutive weeks may be able to take a credit of the lesser of $1,000 or 6.2 percent of wages paid by the employer to the retained worker during the previous 52 weeks. To qualify for the credit, the employer must have paid wages in the last 26 weeks equal at least to 80 percent of the wages for the first 26 weeks. For many employers, this credit matures in 2011 after the 52-week requirement is fulfilled.

Health Care Benefits

Paying 100 percent of health care insurance premiums while also covering medical expenses can quickly drain the resources of someone who is not working.

COBRA allows most employees who are laid off to continue health care insurance coverage through their former employer’s group health care plan – if they can afford to do so. Prior to legislation enacted in 2009 and extended in 2010, COBRA costs included paying the full health care insurance premium as well as up to a 2-percent administrative fee.

The American Recovery and Reinvestment Act of 2009 (ARRA) temporarily lowered beneficiary costs of COBRA by allowing 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 payroll tax withholdings).

During 2010, the period to qualify for the COBRA premium reduction was extended to May 31, 2010. Amendments to ARRA in 2010 also extended the base 18 months of COBRA coverage and the nine-month ARRA extension an additional six months for qualifying individuals.

Individuals are generally not allowed a tax deduction for health insurance premium costs they pay on their own, whether employed or not. However, if their medical expenses exceed 7.5 percent of their adjusted gross income (AGI), insurance costs as well as other medical expenses can be deducted in excess of 7.5 percent of AGI if they itemize.

Retirement Savings

After losing their job, people can easily make mistakes that trigger additional taxes and penalties and reduce the value of their retirement funds. When an employee leaves a job, they generally have the following options:

1. 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 where they will continue to grow tax-deferred. However, as former employees they do not have the same rights as employees, for example, they cannot continue to make contributions.
2. Roll over funds to an IRA or other qualified plan. Individuals can have their former employer directly roll over funds to an eligible tax-deferred account, such as an IRA. However, that may leave them with fewer penalty-free borrowing options. For example, a 401(k) plan may allow a person to take loans for a number of reasons, while penalty-free withdrawals from an IRA are limited to just a few purposes, including paying for health insurance premiums, qualified higher education expenses or first-time homebuyer expenses. Additionally, any plan that has a mandatory cash-out distribution when a person leaves the company is required to provide a direct rollover of funds from the 401(k) to an IRA or other qualified plan for accounts valued between $1,000 and $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, there is a 20-percent withholding and a 60-day time limit in which the entire amount – including the equivalent of the 20 percent withheld – must be deposited into a qualified tax-deferred plan. If this is done, the individual will get the 20-percent withholding back. If they don’t complete the rollover as required, it is considered a cash-out distribution subject to the same taxes and penalties as below.
3. 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. Penalty-free early distribution allowances are allowed if a person is:

• Separated from service by permanent lay off, quitting or taking early retirement during or after the year they turn age 55; or
• Separated from service and establishes a payment schedule of regular equal withdrawals over their lifetime or the joint lives of the participant and the beneficiary.

“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 10 for additional detail on the tax consequences employees face when tapping their 401(k) accounts.)

Job Search and Temporary Work

Many of the costs of finding a job are tax deductible. This includes expenses for resume printing, postage, long-distance calls and faxes; travel, including air, taxi and rail, as well as mileage and tolls; and lodging for out-of-town interviews. However, a person can only claim these expenses if he is seeking a position in the same trade or business.

Moving expenses may also be tax deductible. This applies if someone’s new workplace is at least 50 miles farther from her old residence than the old residence was from their former workplace.

Taking on temporary work, however, can complicate taxes and potentially reduce unemployment benefits. For example, unemployment benefits are reduced or eliminated once a person makes a certain income. This amount, set by each state’s unemployment benefit laws, is generally low. Additionally, people can’t 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.

Taking on temporary freelance work also has its own consequences. Even though the freelancer may see it as temporary, the IRS sees it as self-employed. This means individuals taking this route must pay both income taxes as well as 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 as they must pay the entire amount. The rate is a 15.3 percent tax on net earnings from self-employment. For 2010, it consisted of a 12.4 percent tax on earnings up to $106,800 for Social Security and a 2.9 percent tax for Medicare, which applies to all earnings.

For 2011, the 2010 Tax Relief Act reduces the amount of Social Security tax the self-employed need to pay from 12.4 to 10.4 percent on earnings up to the $106,800 threshold; additionally, they will still be required to pay the 2.9 percent Medicare tax on all self-employment earnings.

There also are some tax benefits for the self-employed. For instance, expenses that can be tax deductible include 100 percent of health insurance premium; deducting expenses for a home office, such as a proportionate share of utilities and the depreciation on the home office; journals; dues for unions or professional associations; advertising and marketing; 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.

However, self-employed people, who exceeded the allowable wage threshold for their state’s unemployment benefits from self-employment, would no longer be eligible for any unemployment benefits even if they stopped working completely.

“People who are self-employed do not pay federal unemployment taxes [FUTA],” said Luscombe. “Therefore, a laid off worker who has unemployment benefits should weigh all the pros and cons of taking on a temporary freelance assignment in advance.”

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).

-- ### --

nb-11-35