Paying taxes and navigating the changing tax codes is stressful enough for anyone, but when you’re unemployed there is an added layer of uncertainty and worry. Learn what you need to know and do to avoid unnecessary surprises.

What you need to know:

Unemployment compensation and severance pay are both fully taxable. This income is taxed at the same rate as any other. However, unemployment compensation is not earned income, which may help with the extra tax credits at the end of the year. You will receive a Form 1099-G from the state reporting the amount of unemployment benefits. Any severance benefits you received will be reported on the W-2 you receive from your former employer.

What you need to do:

One of the simplest things you can do is arrange to have federal withholding taken directly from your check. Some people hesitate to do this because they suspect that they won’t even make enough in the year to owe any taxes. But when you begin making money again you may wind up with a big tax bill, the last thing someone needs after a bout of unemployment. File Form W-4V with your local unemployment office to start withholding. Most tax agencies recommend withholding 10-15%.

Retirement Plans

What you need to know:

Every penny you take from a 401-K plan will be taxed unless you made contributions after taxes were paid. And if you’re under 55 you will pay an additional 10% penalty.

What you need to do:

It is absolutely best to roll those funds over to an IRA. Don’t withdraw funds from your nest egg unless it is really an emergency and no other options exist. If you absolutely have to, set aside the tax due in a special account so you will be prepared at the end of the year. Don’t be surprised. Find out what your tax will be ahead of time and plan to cover it if you do have to withdraw funds.

Deductions

What you need to know:

Some job search expenses may be deductible, if you are filing an itemized return. Resume preparation, postage, travel and other expenses can be deducted. One caveat: you need to be looking for work in the same industry to take these deductions.

What you need to do:

Keep excellent records and save your receipts. Be sure to document what each expense is tied to. This record keeping will pay off if you land a freelance job, because your expenses can be deducted as a business expense.

Self employment

What you need to know:

If you supplement your unemployment with freelance work and your net earnings exceed $400 then you are considered by the IRS to be an independent contractor.

What you need to do:

File a schedule SE to see if you need to pay a self-employment tax. Keep track of your expenses and familiarize yourself with Schedule C. If you plan on doing more freelancing in the future, this is the year to prepare yourself and get organized.

COBRA

What you need to know:

People who lost their jobs between September 1, 2008 and May 31, 2010 only have to pay. Under this program you can receive a rebate of 65 percent of your COBRA premiums for up to 15 months.

What you need to do:

If you are eligible, you will receive this subsidy automatically.

Although unemployment can be stressful, tax time does not have to be. There are tax breaks and credits available in lower income brackets. You may be surprised to find you have a refund coming, so be prepared and file early. You can learn more about taxable unemployment benefits directly from the IRS, by downloading Publication 525.

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