17 Mar 2009
Thomson Reuters Analyst Examines Tax Considerations for the Recently Un- or Underemployed
The Green Ended When Your Job Did, but There May Be a Silver Lining
The failing economy caused many people to lose their jobs in 2008, but according to Lesli S. Laffie, tax analyst for the Tax & Accounting business of Thomson Reuters, lower income due to job loss can lead to increased tax breaks, in the form of deductions and credits. Here’s what taxpayers who lost a job or had a cutback in hours or salary in 2008 should know when they file their 2008 tax returns.
- Consider your sources of income. While severance pay is taxable income subject to federal income tax withholding, the value of job placement assistance offered by an employer is tax-free, unless you had a choice of taking cash or the outplacement help. “For 2008, unemployment benefits are taxable income for which you can voluntarily elect 10% federal tax withholding or make quarterly estimated tax payments, but may be exempt from state taxation,” Laffie points out. (For 2009, the first $2,400 of unemployment compensation is exempt from federal income taxation.) Freelance income or consulting income (i.e., earned from services performed as a non-employee) is subject to both federal income tax and self-employment (SE) tax. This type of income is generally reported on Form 1040 Schedule C.
- Take advantage of deduction opportunities. In computing SE tax, you can deduct on Schedule C expenses incurred in 2008 in performing the services that generated the SE income, such as the cost of licenses, business software, and postage.
“Generally, if you set aside a portion of your home exclusively to regularly pursue activities that result in SE income, a home-office deduction may also be available, if you meet the strict tests,” says Laffie. If eligible, you can deduct “direct” items like the costs of painting or repairing your home office, and depreciation for furniture and fixtures used there, as well as “indirect” expenses, such as the share of utility costs, depreciation, insurance, mortgage interest, real estate taxes, etc., properly allocable to your business use of the home. The deduction for indirect expenses is limited based on the income attributable to your use of the home office, your residence-based deductions that don’t depend on your use of the home for business (e.g., mortgage interest and real estate taxes), and your business deductions that aren't attributable to your use of the home office. Home-office expenses that can't be deducted for 2008 because of these limits can be carried over and deducted in later years. The home-office deduction is taken on Schedule C and Form 8829.
If your home office is also your “principal place of business,” the costs of traveling between your home office and other work locations in that business in 2008 are deductible transportation expenses (not nondeductible commuting costs).
You can also deduct the cost of computers and related equipment “placed in service” in a home office in 2008.
Lower income for 2008 may help you qualify for the medical expense deduction on Form 1040 Schedule A if your costs for that year exceed 7.5% of your 2008 adjusted gross income (AGI). If your former employer paid for some of your medical coverage for a period following termination, the value of this benefit is tax-free. And your medical insurance premiums will probably be higher under your former employer’s COBRA coverage than when you were an employee, leading to a bigger deduction. “But,” says Laffie, “if you were involuntarily terminated after Aug. 31, 2008, you may be eligible for a 65% subsidy for COBRA continuation premiums for up to nine months. This subsidy won’t be taxable in 2009 if your 2009 modified AGI doesn’t exceed $125,000 (for individuals) and $250,000 (if married filing jointly).”
If you have SE income after a job loss, the cost of your medical insurance premiums for that period in 2008 may be deductible on Schedule C, instead of on Schedule A, and so won't be limited by the 7.5% of AGI floor on itemized medical expenses.
Smaller 2008 income may also help you qualify to deduct miscellaneous itemized deductions on Schedule A, if they exceed 2% of your AGI for that year. This would include costs like safe deposit box fees, tax return preparation charges, and job search expenses. To deduct job search expenses, even for an unsuccessful search, you must have been looking for employment in 2008 in the same trade or business in which you were engaged as an employee. Some of the more common deductible job-search expenses are: the cost of resume preparation and distribution; job counseling and referral fees; employment agency fees; telephone charges related to seeking new employment; local and out-of-town travel for interviews (to the extent not reimbursed by the prospective employer); and subscriptions to daily newspapers with classified ads, Internet job-search sites, and professional journals and newsletters. - Don’t forget tax credits. If your 2008 AGI doesn’t exceed $75,000 (single) or $150,000 (married filing jointly), and you or your spouse didn’t receive an economic stimulus payment in 2008, or received less than $600 if single ($1,200 if married filing jointly) plus $300 for each qualifying child, you may be eligible for a “recovery rebate credit” of $600 if single ($1,200 if married filing jointly), plus $300 per qualifying child, minus any stimulus payment received in 2008. A worksheet in the Form 1040 Instructions can help you determine your eligibility for, and the amount of, this credit, notes Laffie, and a “recovery rebate credit calculator” is available at http://www.irs.gov.
Up to a $2,000 Lifetime Learning credit may be available on Form 8863 if you incurred expenses in 2008 for higher education to prepare yourself for a new career, if AGI was under $48,000 for an unmarried taxpayer ($96,000 if married filing jointly). The credit phases out above those AGI amounts. You need not have attended an educational institution full-time in 2008 to qualify, but other rules apply. - Examine retirement issues. If you took a distribution from your former employer’s 401(k) plan in 2008, and didn’t roll the proceeds over into an IRA, you will pay ordinary income tax on the distribution, plus a 10% penalty (unless you qualify for a penalty exception).
But, if your 2008 AGI (as specially defined) is under $101,000 (single) or $159,000 (married filing jointly), you can contribute the lesser of 100% of 2008 compensation or $5,000 ($6,000 if age 50 or over) to a Roth IRA, until April 15, 2009. (The contribution limits are phased out at higher income levels.) While there is no deduction for the contribution, qualified distributions later on will be tax-free. - Bottom line. “Deductions and credits unavailable in earlier years because your income was too high may be within reach for your 2008 return,” says Laffie.
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