One of the surprises waiting for newly unemployed people is that their unemployment compensation is considered taxable income. However, that may not be the only surprise. In this article, I’ll go over a few things that you need to consider if you find yourself unemployed.
What is taxable income?
The general answer is that if you receive income, it is taxable unless it is specifically exempted by law. Among the things considered income are money that someone pays you for working for them, income that you earn in your own business, interest (unless it is exempt), dividends and capital gains. If you owe money and the debt is forgiven, then that is also usually income. (If you want a comprehensive explanation, IRS Publication 525, Taxable and Nontaxable Income covers this topic in just over 40 pages.)
How much tax do I have to pay on unemployment compensation?
That is another question with, “It depends,” for an answer. If your only income is unemployment compensation, you may not have to pay any tax depending on the total amount you receive, your filing status, and deductions and credits. In 2010, the personal exemption was $3,650 and the standard deduction for a single filer was $5,700. If your unemployment compensation totaled $9,350, the standard deduction and the personal exemption would reduce your taxable income to zero. However, additional sources of income or a different filing status could change the answer. If you are married and your spouse works, then that income may also affect the tax you pay. You have the option of having taxes withheld from your unemployment compensation. Read the information that was provided when you filed very carefully.
Let’s take a look at some of the other sources of income that you might have. One source of income is likely to be your previous job. Unless you became unemployed in the last calendar year, then you probably have income from your job this year. It is easy to forget this income, especially if it has been some time since your last check. If you worked in an industry that paid you in stock or options or something similar, then you may also have taxable income related to that compensation.
Many unemployed people make ends meet while looking for full-time permanent work by working temporary jobs or by working as a contractor. This income is taxable, and it could also create problems at tax time if you are not aware of a few things. Money earned doing temporary work or working as a contractor can add up to a nice sum. However, the amount from each individual job may not be enough for the employer to withhold enough tax to keep you from having to pay a large amount and even penalties for underpayment. Be sure to keep track of your earnings from temporary and part-time jobs, and remember that the income is taxable.
If you work as a contractor, you should also be aware of something called Self-Employment Tax. When you are a contractor, you are essentially self-employed, and you become responsible for both the FICA (Social Security) that would normally be deducted from your check by an employer and the portion that would be paid by the employer.
Savings and Investments
Do you have investment income? If you had been a regular saver or investor, then you may have accounts that pay you interest, dividends, and capital gains each year. It is easy to forget about this income until you receive the 1099’s from your bank or investment company.
You may be using that savings or investments to pay your living expenses. If your money was in a checking or savings account, the only consequence of your withdrawals is that your balances are getting smaller. However, if your money is in stocks or bonds (including mutual funds) or in special accounts like IRAs you may face some tax consequences.
When you sell mutual funds or stocks and bonds, then you are subject to capital gains tax on the difference between what you paid and what you received when you sold. If you sold for less than you paid, then you have a loss.
If you withdraw money from IRAs or take distributions from a pension or annuity, then you may be required to pay tax on the amount you withdraw. In addition, depending on your age and how you withdraw the money, you may also be subject to additional taxes. You may also find that some annuities have surrender charges.
These are just a few of the issues that might be of interest to people that are unemployed. If you are unsure of your tax liability, be sure to contact a CPA or trained tax professional to discuss your unique situation.