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Tax Implications of Losing Your Job

by
Spencer Wilson
on
10/28/2020
Tax Implications of Losing Your Job

Losing your job is emotionally devastating, no matter whether you’re an hourly worker or a white-collar wage earner. The psychic damage and anxiety affect you whether you loved your work or hated it, as job satisfaction comes second to economic security and self-esteem. Though taxes may be the last thing on your mind as you strategize your next steps, you need to take some time to consider the following issues. Failing to do so has the potential to make a bad situation even worse.

Severance

Many companies provide a compensation package to workers that have been let go or pay them for unused vacation or sick time. This severance pay may feel like extra cash in your pocket that you can use to tide you over, but the IRS considers it income, and you will have to report it when you file your W-2 and pay taxes on it, just as if it had been part of your wages.

Unemployment

Unless you are lucky enough to get a new job immediately or don’t qualify, you’re probably going to file for unemployment compensation to help you replace your salary. Under the CARES Act, unemployment payments have been supplemented, but the COVID-19 emergency didn’t change the fact that the benefits are taxed by the federal government, and depending on where you live they may be taxed by your state as well. 

To avoid facing a big tax hit when it’s time to file your taxes, consider submitting Form W-4V (Voluntary Withholding Request) when you file for unemployment so that your state will withhold 10% of your benefit, or else make a point of setting aside some of the monies you receive for the specific purpose of softening the blow at tax time.

Health Insurance

When you lose the job that has been providing your health insurance through a group coverage plan, you are going to need to find a replacement or face the possibility of being uninsured, being charged a penalty by your state for lacking insurance (depending upon where you live), or both.  To replace your employer-provided health insurance you have two options:

  • COBRA – COBRA stands for Consolidated Omnibus Budget Reconciliation Act, which mandates that continuation coverage be made available to covered employees, their spouses or former spouses, and their dependent children who were covered on the employer’s plan and then lost it when their employment is terminated. This coverage is only available or up to 18 months after the job loss and is generally extended to the employees of private employers with 20 or more employees. State and local governments offer COBRA continued coverage as well. COBRA has a well-earned reputation for being costly, as those who are eligible suddenly find themselves paying the full amount for coverage that had previously been paid by both their employer and their own contribution, plus an additional 2% to cover administrative costs of the program.
  • The Health Insurance Marketplace – The government health insurance Marketplace usually limits the time for enrollment, but it is available outside of the normal window when existing health coverage is lost. In addition to offering a flexible option for coverage, the loss of income caused by your job loss may make you eligible for a premium tax credit for the time period when you no longer have employer-provided coverage.For those who had originally opted to purchase coverage through the Marketplace, notifying the Marketplace of your job loss may lead to eligibility for a bigger advance premium tax credit. It is important to let the Marketplace know about anything that changes your income, for better or worse, as it can make a difference in the amount you get as a credit or have to repay at tax time.

Employer Pension Plan

If you had a pension or retirement fund with your employer, you need to determine whether you can leave your funds in their plan or if you need to move them into a new IRA account. You only have 60 days from the time you leave your employer to do the latter and doing so may trigger an unexpected tax hit. This is because the employer is required to withhold 20% of any distribution for federal taxes, and that means that only a portion of the total value of your pension fund will be deposited in the new account.  The only way to avoid being taxed on the 20% being withheld is to make up for it with other funds that you deposit into the new account. 

After you find a new job, you may want to roll your pension plan into your new employer’s plan. If you do so, make sure that you don’t commingle the funds into any other IRA account: They need to be kept separate.

It is easy to find yourself looking at your pension plan’s holdings and think about the financial relief offered by just keeping them as cash. As tempting as this may be, it’s important to remember that the money you don’t rollover and hold onto will likely be taxable and will also be subject to a 10% early withdrawal penalty if you are under the age of 59 1/2. This is one area where the provisions of the CARES Act can make a difference, because it lets you take distributions under $100,000 from January 1, 2020 through December 31st, 2020 from qualified plans or IRAs penalty free. Taxes are spread out over a three-year period and you can redeposit them into an IRA or other qualified plan over the next three years if you choose to do so.  This favorable tax treatment is specifically COVID-19 related, and if your job loss is related to the pandemic, then your circumstances are what the exception was created for. 

Having to Sell Your Home

Whether you sell your home as a direct result of your job loss or you just happen to be selling it now, you can exclude up to $250,000 of any gain on its value (or $500,000 if you and your spouse both qualify for the exclusion) as long as you used it as your primary residence for two out of the last five years.  Even people who don’t meet that eligibility requirement but who have lost their job can get a gains exclusion that is prorated.

Losing your job is a significant life event. For some it is soul-crushing, while others view it as a door opening to a new future. One way or another, when a job loss occurs you need to know what your tax obligations are, and during the pandemic you need to know about exceptions that may alleviate some obligations that otherwise would exist. To make sure that you’re filing all of the right paperwork and doing everything possible to optimize your situation, contact your tax professional.

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Spencer Wilson

Spencer Wilson

Spencer Wilson, EA is a tax preparer based in Long Beach, CA. Spencer Wilson Financial Management Services has been serving the Greater Los Angeles Area and Orange County since 2004. <br /> We began in the heart of Naples in Long Beach and we continue to work hard offering tax preparation and planning, business accounting and bookkeeping and payroll services . <br /> We have helped many different people and businesses succeed financially and take control over their finances.

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