There aren’t many – if any – perks of being unemployed. We all know that.
These government-funded unemployment benefits can be very helpful, but what many people forget is that this supposed “free ride” isn’t actually very free.
Many people are surprised to learn that any unemployment compensation you receive from the government is, in fact, taxable.
That’s right: When you submit your yearly tax return in April, you’ll have to include that money you received for being unemployed as part of your income. It may sound a little backwards, but the government still considers that your income.
You can avoid a surprise tax bill in April if you decide to have taxes withheld from your unemployment check (exactly like you would if you were employed by filling out a W-4).
You’ll just need to fill out a W-4V form and 7, 10, 20, or 25 percent (your choice based on your overall income) will automatically be deducted from your unemployment check. Remember that you’ll still have to include these amounts in your tax return to calculate your exact tax bill, but the initial withholding can help the sticker shock on your overall tax bill.
Another point to remember is that ALL unemployment benefits are taxable for tax years after 2009.
Early retirement plan distributions
Many people who become unemployed will draw from other sources to fund their living expenses until they find work again.
Although it is risky and not recommended, many will draw from their retirement accounts when they’re without a job. This is a last resort, and we recommend going through alternative sources first (like seeking government aid, as mentioned above), but if this is 100 percent necessary, here’s how you would handle this situation:
If you withdraw money from your Individual Retirement Account (IRA) or 401(k), you will be subject to tax penalties for early withdrawal (assuming you’re not at least 59 1/2 years old).
For both accounts, early withdrawals are taxable and an additional 10 percent tax is collected on these withdrawals. The government encourages people to leave their retirement accounts untapped until they’re actually at retirement age, which is why they levy such high taxes on these accounts.
One major exception to this rule is our friend, the Roth IRA. You actually can withdraw funds from your Roth IRA, but there is one catch: You can only withdraw your contributions without penalty. The earnings on your Roth IRA cannot be withdrawn before age 59 1/2 without penalty.
Remember: these are high-level rules, and there are several exceptions related to disability and transfer of funds to other accounts or beneficiaries, so double check with the IRS if you have any questions.
Tax breaks for unemployed
Earned Income Credit. Many people who are unemployed become eligible for the Earned Income Credit because their income drops so significantly. This tax credit was designed for those who earn small amounts of income.
To qualify for 2014, your Adjusted Gross Income (AGI) must be less than:
- $46,227 ($51,567 married filing jointly) with three or more qualifying children
- $43,038 ($48,378 married filing jointly) with two qualifying children
- $37,870 ($43,210 married filing jointly) with one qualifying child
- $14,340 ($19,680 married filing jointly) with no qualifying children
The great thing about this credit is that it a “refundable” credit – meaning even if you owe zero tax, you can still receive a refund.
Job Search Expenses. Anyone who is job searching is eligible to deduct certain job search expenses. But be warned – you must itemize your deductions to claim these expenses AND they (in addition to other miscellaneous itemized deductions) must exceed 2 percent of your AGI.
That may seem daunting, but it’s a good start if you just keep track of these job search expenses. Keep records of these qualifying expenses:
- Employment placement organization fees
- Resume printing
- Phone calls
- Travel and transportation
- Moving expenses
For a more detailed explanation of job search deductions and/or itemized deductions, check out these Money Under 30 articles:
Questions? Have you had to deal with unemployment taxes recently?
Earn and save more with our free course:
What would you do with more money in your bank account? Join over 15,537 other young professionals receiving our best money hacks to get out of debt by 30, increase your income (starting this year) and invest for financial freedom.
100% free! I will NOT spam you and I will NOT share your email.