If you lose your job or otherwise become unemployed, one of the first things you should do is determine how your new financial situation affects your income taxes.
Take note of these areas that may change.
How Unemployment Affects Your Taxes – TaxAct
One question that may arise in your mind is: Does unemployment get taxed?
Well yes, the unemployment benefits are taxable. Long ago, unemployment benefits were exempt from income tax. Unfortunately, that’s no longer true.
You don’t have to pay Social Security and Medicare taxes on your unemployment benefits, but you do have to report them on your tax return as income.
You can choose to have income tax withheld from your unemployment benefits, if necessary, to avoid an unpleasant surprise next year when you file your return. Before you do, however, make sure that’s necessary.
You could get a hefty tax refund this year
On the other hand, if you’ve been having income tax withheld from your pay for a substantial portion of the year already, you may be way ahead on paying taxes for this year.
In a progressive tax system, such as we have in the U.S., higher levels of income are taxed at much higher rates.
When your employer takes taxes out of your paycheck, the payroll department calculates your income tax withholding as if you will earn the same amount all year.
When you get laid off and make far less over the year, you may get a large portion – or all – of your income tax withheld back as an unemployment tax refund.
You can’t get that over-withheld income tax back until after the end of the year. However, you may be able to make adjustments to minimize your over-withholding, giving you more money to live on now.
You may need to adjust your spouse’s income tax withholding
One way you can increase your current after-tax income, if you and your spouse were both working, is to have your spouse adjust his or her income tax withholding.
If your spouse’s withholding is based on the assumption you both earned an income, he or she is almost certainly having too much withheld for your current circumstances.
The working spouse should file a new Form W-4 with his or her employer to adjust the amount of income tax withheld.
You may be able to deduct job-hunting expenses
Job-hunting expenses are deductible as miscellaneous deductions on your tax return. You’ll need to have substantial job-hunting or other miscellaneous deductions before they actually reduce your income tax bill.
You can only deduct your total miscellaneous deductions to the extent that they exceed 2% of your adjusted gross income.
However, if your income is much lower this year, you may reach that amount more quickly than you expect.
Keep track of your job-hunting expenses, such as transportation to interviews (including parking and tolls), subscriptions to online job search services, admission to job fairs, and resume consultations.
Tuition and expenses may also lower your tax bill
Taking classes and upgrading your work skills doesn’t just help you get back to work faster, it can also lower your tax bill.
You may qualify for an education tax credit or a tax deduction for your tuition and expenses, even if your classes are not in pursuit of a college degree.
It’s never been more important to estimate your taxes
Becoming unemployed changes almost everything about your tax situation – your total income, your withholding, and all the tax calculations based on those numbers.
You may qualify for tax benefits for which you made too much money when you were working. You may need to have more or less income tax withheld.
Instead of guessing, be sure to use TaxAct to estimate your tax liability for the year as closely as possible.
When your finances change, hopefully for the better, estimate them again. Money is usually tight when people are unemployed.
It’s the worst possible time to have too much income tax withheld, reducing your monthly income, or too little so you fall behind on your tax liability.