Tax Tips for the Unemployed

Employ These Strategies to Minimize

IRS’s Bite When You Can Least Afford It

By Ken Segal

For the estimated 8.6 million unemployed Americans, dealing with finances after a layoff can be very stressful. While searching for your next job and figuring out how you’re going to pay your bills, you also must consider the numerous tax implications of your new situation. Come tax time, that burden can seem like a bad joke. Depending on how long you’ve been out of work, your Federal tax return may look quite different this year than it did while you were employed, but the news isn’t all bad. In fact, there may be a silver lining in the form of deductions you never could claim before

The Good News:

Claiming New Deductions 

All taxpayers are allowed to deduct out-of-pocket medical expenses that exceed 7.5 percent of their adjusted gross income (AGI). However, most working Americans can’t take advantage of that deduction, because their employer pays for the bulk of their care through insurance and their adjusted gross incomes are too high to allow a deduction. Unemployed individuals who pay for their own benefits under the Consolidated Omnibus Budget Reform Act of 1985 (didn’t you always wonder what COBRA stood for?) may be able to claim a deduction, if they exceed the 7.5 percent threshold.  COBRA allows you to continue your health plan at your own expense if you are laid off, but it can easily cost $700 per month for a family of four, because you are now paying the entire cost of insurance yourself. 

In addition to some medical expenses, some of your job-search expenses for employment in your current trade or business may also be tax-deductible as miscellaneous expenses.  If you itemize your 2002 taxes, you may be eligible to deduct your job-search expenses to the extent that they, along with your other miscellaneous itemized deductions, exceed 2 percent of your AGI. Miscellaneous itemized deductions could include legal fees related to protecting your employment status, employment and outplacement agency fees (not paid for by your former employer), resume typing and printing, advertising, long-distance phone calls, postal and travel expenses (including airfare, lodging and meals). Moving fees associated with relocating for a new position may also be deductible. (This deduction is not subject to the 2 percent or “same trade or business” limitations.)

Unemployed individuals may also be able to write off education expenses, if the period of unemployment is very temporary and the classes taken were meant to enhance their current job skills.  Classes that help a job seeker switch careers do not qualify.  The bottom line is to always save your receipts so that you’ll be prepared to document your deductions when you claim them.

The Bad News: Yes,

Unemployment Benefits and

Severance Pay Are Taxable! 

             Many people fail to realize that unemployment benefits are still considered taxable income.  How much you owe depends on your tax bracket.  If unemployment was your only income last year, it may escape taxation completely.  (Check www.irs.gov to see if you qualify for the Earned Income Tax Credit.) However, if you are filing jointly and have a spouse who brought in other income, you could owe close to 39 percent at the Federal level.  Ultimately, if you failed to have money taken out of your unemployment checks for income taxes, you could face a whopping tax liability on your 2002 returns.

If you received severance pay, you also must consider its effect on your taxable income.  Severance is considered ordinary income and is taxed at the appropriate tax rate for each person’s taxable income. Some severance packages worth tens of thousands of dollars can actually bump you into a higher tax bracket. 

According to the IRS, for the employer’s convenience, the company can withhold at a flat rate of 27 percent on the check.  This means that if you were in one of the higher tax brackets, you could very well end up owing money come April 15.  However, while a lump-sum payment can lead to a greater tax liability, it’s still recommended over opting for smaller, ongoing payments.  One reason is that if the employer declares bankruptcy during the payout period, it would have no legal obligation to pay the remaining severance to you.  

‘Sell Your Stock Losers’—

and Other Employable Unemployment Strategies 

Temporary Work: If you performed any temporary consulting work between jobs, you are officially considered self-employed, and you are required to pay income tax.  If you earned more than $400, you also must pay Social Security, Medicare and SECA (Self Employment Contributions Act). That’s why, before you accept consulting jobs, you should carefully calculate whether the income is worthwhile. If you’re doing a few low-budget projects, you may not make more money, after you pay taxes, than what you’d receive in unemployment. If you have considerable self-employment income, consider setting up a Keogh or SEP-IRA to shelter some of that income from taxes.

Selling Stock: Unemployed people looking for tax deductions also may want to consider selling some of the losers in their stock portfolios.  If losses outnumber gains, the IRS allows investors to write off those losses, up to $3,000 (or $1,500 if married filing separately) of ordinary income. In addition, if cash flow is tight, this may be a good time to sell some select stocks and access cash to pad your emergency fund, pay your taxes or decrease your debt.

Pre-paying Taxes: If you’re anticipating a big state tax hit, you may also consider pre-paying estimated state and local taxes, because they are deducted against Federal taxes.  Pre-paying these taxes also locks in the deduction for this calendar year.

Put an Expert to Work for You. Finally, keep in mind that it is especially important to get professional help when dealing with complicated tax issues, such as unemployment.  Be sure to see a qualified tax consultant and a certified financial adviser to help you navigate this unfamiliar territory. Who knows, they may even be able to give you some good leads to help you find your next job!

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Ken Segal is an American Express Financial Advisor, based in Philadelphia, with 13 years’ experience in compensation and benefits analysis and financial planning. For further information, contact him via phone (215-940-0123) or e-mail: kenneth.m.segal@aexp.com.

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American Express Financial Advisors Inc. Member NASD. American Express Company is separate from American Express Financial Advisors Inc. and is not a broker-dealer. This communication was published in April 2003 in the United States for residents of New Jersey and Pennsylvania only, and this advisor is licensed only in the states of New Jersey and Pennsylvania. This information is provided for informational purposes only. The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor. The views expressed may not be suitable for every situation. 

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For more information, read “How Low Can I Owe? If You Dread Tax Time, Here’s How You  Can Ease—and Even Postpone—the Pain.”