Tax Consequences of Losing Your Job
- Severance Pay
- Unemployment Compensation
- Health Insurance
- Employer Pension Plan
- Coronavirus-related Distributions
- Home Sale
If you have lost your job, there are a number of tax issues you may encounter. How you deal with these issues can profoundly impact your taxes and finances. The following are typical issues related to tax treatment:
Your employer may provide you with severance pay. Severance pay and payment for unused vacation time will be included in your W-2 income, and both are fully taxable.
If you do not find another job right away, you generally qualify for unemployment compensation. Unemployment benefits, both the regular benefits you receive from your state unemployment department and the enhanced unemployment payments during the COVID-19 emergency, are taxable for federal purposes and may or may not be taxable by your state of residence.
To minimize the tax you may owe when you file your 2020 tax return, you may want to request federal income tax withholding of 10% of the unemployment benefit amount. Do that by submitting a Form W-4V (Voluntary Withholding Request) to your state’s unemployment office.
If you lose your job and you had health insurance through your employer’s group health coverage plan, you will need to determine your available options for continued coverage via COBRA or a replacement policy. If you give up coverage, you may be subject to penalties in some states for not being insured.
- COBRA Coverage - The Consolidated Omnibus Budget Reconciliation Act (COBRA) requires continuation coverage to be offered to covered employees, their spouses, former spouses, and dependent children when group health coverage would otherwise be lost. COBRA continuation coverage is often more expensive than the amount that active employees are required to pay for group health coverage because the employer usually pays part of the cost of employees’ coverage, whereas 102% of the total cost can be charged to individuals receiving continuation coverage (the extra 2% covers administration costs). COBRA generally applies to private-sector employers with 20 or more employees and state or local governments that offer group health coverage to their employees. In most cases, COBRA coverage is limited to 18 months.
- Health Insurance Marketplace Coverage – When existing health coverage is lost, a family may purchase health insurance through a government health insurance marketplace outside of the normal enrollment window. In addition, depending upon your income for the year, you may qualify for the premium tax credit for the part of the year when you don’t have coverage through your employer, which will help pay for the insurance.
If your coverage was already through a marketplace and not your employer, you should notify the Marketplace that you’ve lost your job and that your income has decreased, as you may then be eligible for a higher advance premium tax credit.
However, also advise the Marketplace once you are employed again so that appropriate adjustment can be made to the advance premium tax credit amount. This may alleviate having to repay some of the credit when you file your 2020 return.
Employer Pension Plan
Depending upon the provisions of your employer’s pension plan, you may have the option of leaving your retirement funds in the employer’s plan or moving the funds to your IRA account. You can have the funds transferred to your IRA or take a distribution and roll it into your IRA within 60 days.
However, this is where a tax trap exists; for a distribution, the employer is required to withhold 20% for federal taxes, meaning only 80% of the funds will be available to roll over and the remaining 20% will end up being taxable unless you can make up the difference with other funds.
In the event you ever want to roll those funds into a new employer’s retirement plan, those retirement distributions should not be comingled with other IRA accounts.
Should you be tempted not to roll the funds over, be aware that the distribution will generally be taxable, and if you are under the age of 59½ there will also be a 10% early withdrawal penalty. However, the CARES Act allows qualified taxpayers to make COVID-19-related distributions from qualified plans or IRAs (not to exceed $100,000 from January 1, 2020 to December 31, 2020) and receive favorable tax treatment. These distributions are penalty-free; they are taxed over three years and can be redeposited to an IRA or qualified plan within three years.
If you relocate and have to sell your home and have owned and occupied the home as your primary residence for 2 of the previous 5 years, you will be able to exclude up to $250,000 of the gain ($500,000 if you are married and you and your spouse qualify for the exclusion). If you do not meet the 2-out-of-5-years qualifications, you will be allowed a prorated gain exclusion because you have lost your job.As you can see, there are a number of issues that may apply when a job loss occurs. This is even more relevant during the coronavirus emergency. To learn more about how these issues might affect your particular situation, please give this office a call.