Does No Job Mean No Taxes?

I’ve heard this question a lot. The answer is, “It depends.” 

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.

Previous Employment
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.

Odd Jobs
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. 

The first Form 1040 in 1913

Take a look at the first 1040. The form and instructions are only four pages long.
The first Form 1040 was produced in 1913 after the 16th Amendment was ratified. The amendment said,

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

The 1913 Form 1040 was three pages long, and it was accompanied by one page of instructions. The normal tax rate was one percent.

The normal tax of 1 per cent shall be assessed on the total net income less the specific exemption of $3,000 or $4,000 as the case may be. (For the year 1913, the specific exemption allowable is $2,500 or $3,333.33, as the case may be.)

There was also an additional or super tax on taxable income above $20,000 as shown below.

Rate	on the amount over	and not exceeding
1%	$20,000	$50,000
2%	$50,000	$75,000
3%	$75,000	$100,000
4%	$100,000	$250,000
5%	$250,000	$500,000
6%	$500,000

How to fix an error on your individual income tax return

Does this sound familiar?

• You filed the return.
• You cashed the refund check, or you wrote out the check for the taxes you owed.
• When you were filing all of your tax paperwork you discovered you left something off of your return, or you received a notice from the IRS.
• You panicked.

Good news. There is no need to panic. File an amended return. If your CPA completed your return, call your CPA and ask him or her to amend the return. If your return is simple, you can probably do it yourself.

What you will need
Whether you prepare the amended return yourself or send it to your CPA, you will need a few things before you can get started.

• A copy of your return and instructions for the forms. (If you need prior year forms and instructions, you can call 1-800-TAX-FORM (1-800-829-3676). You can also download them from http://www.irs.gov/.
• Form 1040X and instructions (Do not simply re-file a new 1040, 1040A, or 1040EZ!)
• Any additional supporting documents
• Any letters or notices you received from the IRS

How to get started
The first step is to organize your documents. It is a good idea to group your documents into categories such as income, deductions, or credits. You’ll want to separate out documents that go with specific schedules. Once you have done that review the original instructions for the forms you filed. This should help you be certain that you understand the changes that you want to make.

The 1040X is a multi-purpose form. Taxpayers have many reasons for amending returns. This means that you may not need to complete all of the lines on the form. Be sure to check the instructions.

The simplest way to make your changes is to make notes in the margins of your original return. Once you have made all of your changes and reviewed them, you can enter the changes onto the Form 1040X. If you use tax software, be careful to follow the directions provided by the software company. Typically you will make a copy of the original file and modify the copy instead of working on the original. The software will also have an option to prepare an amended return.

Once you file the amended return, file it and all of your supporting documents with your other important papers. If you have a CPA, you may also want to send a copy of the amended return to him or her to keep in your files.

Deadlines
File Form 1040X only after you have filed your original return. It is important to realize that the interest and penalty clock rarely stops ticking. If your changes result in a higher tax liability, then you should file an amended return and pay the tax as soon as you possibly can so that you can avoid additional penalties.

If your changes result in a lower tax liability, then you may be due a refund. Generally, for a credit or refund, you must file Form 1040X within 3 years (including extensions) after the date you filed your original return or within 2 years after you paid the tax, whichever is later. There are some exceptions to this time limit for people who are unable to manage their own affairs. Check with your CPA or review Publication 556 Examination of Returns, Appeal Rights, and Claims for Refund

How to calculate estimated taxes

If you owed tax additional tax this year, it is possible that you should pay estimated taxes. If you are self employed it is very likely that you should pay estimated tax. This is what the IRS has to say about the topic in Publication 505.

General Rule

In most cases, you must pay estimated tax for 2010 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2010, after subtracting your withholding and refundable credits.
2. You expect your withholding and refundable credits to be less than the smaller of:

• 90% of the tax to be shown on your 2010 tax return, or
• 100% of the tax shown on your 2009 tax return. Your 2009 tax return must cover all 12 months.

You can use a worksheet to make a more accurate calculation. If all of your income is subject to withholding, you probably do not need to pay estimated tax. You will want to review your withholding with your employer.

You do not have to pay estimated tax for 2010 if you meet all three of the following conditions.

1.  You had no tax liability for 2009.
2. You were a U.S. citizen or resident alien for the whole year.
3. Your 2009 tax year covered a 12-month period.

 There are special rules for farmers, fishermen, certain higher income taxpayers, aliens, and estates and trusts.

• Farmers and Fishermen
• Higher Income Taxpayers (The percentage of 2009 AGI changes from 100% to 110%.)
• Aliens (Resident aliens should refer to Publiciation 505. Nonresident aliens should review Publication 519 for more information about Form 1040-ES (NR))
• Estates and Trusts (use Form 1041-ES, Estimated Income Tax for Estates and Trusts, to figure and pay estimated tax.)

Figuring out estimated tax

If you are self employed it is very likely that you should pay estimated tax. This is what the IRS has to say about the topic in Publication 505.

General Rule
In most cases, you must pay estimated tax for 2010 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2010, after subtracting your withholding and refundable credits.
2. You expect your withholding and refundable credits to be less than the smaller of:

• 90% of the tax to be shown on your 2010 tax return, or
• 100% of the tax shown on your 2009 tax return. Your 2009 tax return must cover all 12 months.

You can use a worksheet to make a more accurate calculation. 

You do not have to pay estimated tax for 2010 if you meet all three of the following conditions.

1. You had no tax liability for 2009.
2. You were a U.S. citizen or resident alien for the whole year. 
3. Your 2009 tax year covered a 12-month period.

There are special rules for farmers, fishermen, certain higher income taxpayers, aliens, and estates and trusts.

• Farmers and Fishermen
• Higher Income Taxpayers (The percentage of 2009 AGI changes from 100% to 110%.)
• Aliens (Resident aliens should refer to Publiciation 505. Nonresident aliens should review Publication 519 for more information about Form 1040-ES (NR))
• Estates and Trusts (use Form 1041-ES, Estimated Income Tax for Estates and Trusts, to figure and pay estimated tax.)

Need tax help? Ask the IRS. Really.

People love to hate the IRS. It is a government bureaucracy. It collects taxes. It enforces tax laws. (Congress writes the laws, but that is another topic.) It makes mistakes. What is there to like?

Actually there is a lot to like. The IRS’ mission statement is to, “Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.” That is a tough job. According to the IRS:

This mission statement describes our role and the public’s expectation about how we should perform that role.

• In the United States, the Congress passes tax laws and requires taxpayers to comply.
• The taxpayer’s role is to understand and meet his or her tax obligations.
• The IRS role is to help the large majority of compliant taxpayers with the tax law, while ensuring that the minority who are unwilling to comply pay their fair share.

One thing the IRS does very well is provide information, lots of information. Sometimes the information is overwhelming. Sometimes it is contradictory. Sometimes it is late. (In defense of the IRS, it promulgates rules and writes instructions according to laws passed by Congress. That has a lot to do with conflicting rules and with delay. For good examples of this, read up on the AMT and the Estate Tax.)
 
Another thing the IRS does well is make it easy to get help. You can call, write, e-mail, fax, or even stop by a local office. If that does not get you the help you need, you can even contact the Taxpayer Advocate Service. (If you have ideas about how to make the process better, the IRS even has a way for you to provide feedback and submit ideas for improvement, the Taxpayer Advocacy Panel.)

Here are five ways to get help from the IRS.

1. Call the IRS: (800) 829-1040
2. Call the IRS.gov Web Site Help Desk: United States and Canada (800) 876-1715 / International (319) 464-3291
3. E-mail the IRS.gov Web Site Help Desk:  irs.gov.website.helpdesk@speedymail.com
4. Check out the IRS.gov Frequently Asked Questions (FAQ) page: http://www.irs.gov/faqs/index.html  
5. Stop by your local office or Taxpayer Assistance Center. Click here to find out how to contact your local Center. http://www.irs.gov/localcontacts/index.html  

For other help, check out the directory at http://www.irs.gov/contact/index.html