Tax Tips for the Unemployed

Michele Petties felt as if she had been hit by a ton of bricks. Despite having a master’s in business administration and more than 20 years of corporate experience, the single mother of two was laid off from her five-year post in February as a project director at a healthcare company.

Petties’s comfortable lifestyle and $112,000 base salary plus bonus were replaced by the stress of trying to stretch her $1,320 monthly unemployment benefits and savings to make ends meet for herself and her two daughters–Kennedy, 11, and Sierra, 10–while looking for another job. “It’s been very difficult. It’s been a tough job market,” says the 45-year-old divorcee.

While she has been proactive about her job search, she’s preparing to file a tax return in 2013 that includes credits and deductions she never could have taken as an employed person, such as job search deductions.

It’s important for the unemployed to be organized, proactive, and informed. If you’re looking for work, here are tips to get you through the tax season:

File a tax return.
Unemployment benefits are taxable. Don’t make the mistake of thinking you haven’t received enough income to file a tax return. “Most unemployed people should file,” says Robbie Hampton, a founding partner of Bishop, Hampton & Associates L.L.C., a certified public accounting firm in Stockbridge, Georgia. Those who owe the government come tax time but don’t file could be subject to a failure-to-file penalty,” says Hampton, The penalty is up to 25% of the unpaid taxes. They could also be subject to a failure-to-pay penalty.

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Unemployment benefits are taxable at the federal level, but some states do not tax this income, says William Perez, a San Francisco-based enrolled agent, which is the highest credential the IRS awards and affords the recipient unlimited practice rights.

Be aware of taxes on no-penalty 401(k) withdrawals.
Immediately after a layoff,

you might be tempted to take out a no-penalty withdrawal from your 401(k) (no-penalty withdrawals are not subject to the 10% early-withdrawal penalty, and can be taken out for special circumstances such as a layoff or permanent disability), but it’s still taxable income, says Perez.

Surprise! Your severance package is also taxable.
Petties’s six weeks of severance pay was taxed at a higher rate than her regular income because the Internal Revenue Service considers such pay to be “supplemental wages,” such as money earned from contract or freelance work. Such earnings may be subject to a self-employment tax of 13.3% (10.4% for Social Security and 2.9% for Medicare), which you’re required to pay if you’ve earned $400 or more.

Keep track of job search costs.
Petties may be able to deduct on her federal income tax return expenses related to searching for a new job. As of October, she had spent about $645. The costs of making

résumé copies, travel to interviews, and outplacement agency fees can be deducted from one’s taxable income if they exceed 2% of a person’s adjusted gross income and if they are itemized on the tax return, says Hampton.

Hampton stresses that only those who lose their jobs involuntarily can deduct these expenses, and only if they haven’t already been reimbursed by an employer.

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The cost of relocating to a new job can be deducted if the new job is at least 50 miles farther away from the former home than the former home was from the former job. The costs, however, are only deductible if you worked full time for at least 39 weeks after the move, she warns.

Also keep track of healthcare costs.
Health insurance costs under the Consolidated Omnibus Budget Reconciliation Act or an individual plan are deductible, but only if medical expenses exceed 7.5% of adjusted gross income, Perez says.

After

Petties’s layoff, she purchased COBRA coverage for herself; she has applied for her daughters to be insured under a state plan for children in low-income households because their father recently lost his job, too. Petties plans to deduct the cost of paying for COBRA, especially since it claims a significant 26% chunk of her monthly unemployment benefits.

Look into the Earned Income Tax Credit.
Check eligibility for the earned income tax credit, or EITC, which is a credit (not a deduction, which lowers your taxable income; a credit reduces the amount of tax you pay) for low- to moderate-income earners who have worked at some point during the year. The credit varies depending on the filer’s income and number of dependents. Petties will claim the EITC credit, $5,236, for a single filer with two qualifying children for the 2012 tax year, since her 2012 income will fall below the IRS’s threshold of $41,952.