COVID-19

Tax issues for the newly unemployed

Unemployment is at levels not seen since the Great Depression of the 1930s. If you got laid off, taxes are probably the last thing you want to have to think about. However, you need to understand the answers to these questions: 

Is unemployment taxed? 

Yes. Unemployment is taxable income. Income taxes apply to state unemployment benefits and the extra $600 per week paid by the federal government through July 31 (unless extended).  

But you only have to pay income tax on unemployment benefits, not Social Security and Medicare taxes (also called FICA taxes).  

When you sign up for unemployment, you can have 10% of your payments withheld by your state unemployment office and sent to the IRS. To do so, complete IRS Form W-4V. 

It’s up to you to decide whether you want this money withheld. If you don’t opt for 10% withholding, you could owe income tax on your unemployment benefits when you file your 2020 taxes. You may wish to set some money aside for this purpose. 

By January 31, 2021, your state unemployment agency will send you (and the IRS) Form 1099-G showing total 2020 unemployment payments.  

Is severance pay taxed? 

Yes. Severance pay gets treated the same as employee wages for tax purposes. For this reason, you must pay both income tax and Social Security and Medicare tax on it.  

Your employer will include this amount on your Form W-2. It will also withhold federal and state taxes from your severance and send the money to the IRS and your state tax agency (if your state has income taxes). This way, you won’t owe any extra when you file your 2020 tax return. 

Is sick leave and vacation pay taxed? 

Yes, and yes. Such payments get treated the same as wages, just like severance pay. 

Are gifts from family or friends taxed? 

Usually no. If a family member or friend gives you more than $15,000 during 2020, he or she might have to pay a gift tax on the amount. But you wouldn’t have to owe anything. 

Are loans taxed? 

No. A loan is money you have to pay back. Personal loans are not taxable income. This rule applies whether you get a loan from a bank or family member or friend.  

You also don’t have to pay any tax if a private lender—a relative or friend—forgives a loan as a gift. 

Are food stamps or other public assistance taxed? 

No. 

Can you file your 2020 tax return early and get your tax refund? 

No. Individual income tax returns are calendar year-based. You can’t file your 2020 tax return until January 2021. If you file your return that early, you could get your refund as soon as February 2021. 

If you sell stuff, do you have to pay tax on the proceeds? 

Maybe. If you sell property you own at a profit, you are supposed to report the income, and you may have to pay income tax on it.  

You have a profit on an asset sale only if you sell it for more than you paid for it. For example, if you sell stock shares you bought for $1,000 for $5,000, you have a $4,000 taxable profit.  

If you sell your home, you usually don’t have to pay any income tax on up to $250,000 of profit if you’re single or $500,000 if you’re married. To qualify for this home sale exclusion, you must have lived in the home for two of the last five years. 

Can you withdraw money from your retirement accounts without paying penalty taxes? 

Yes. Ordinarily, if you withdraw money from an IRA or tax-qualified retirement plan like a 401(k), before age 59.5, you must pay a 10% penalty tax on the withdrawal. This is in addition to regular income taxes. However, there are some exceptions. 

Hardship exemptions: There are special hardship exemptions from the 10% penalty. You don’t have to pay it if you are age 55 (age 50 for qualified public safety employees) in or after the year you lost your job.  

You also don’t have to pay the additional 10% income tax on the money you take out of an IRA to pay for medical insurance for yourself, your spouse, and your dependents. To qualify, you must have lost your job and received unemployment compensation for 12 consecutive weeks. 

CARES Act: The Coronavirus Aid Relief and Economic Security Act (CARES Act) enacted by Congress relaxes the retirement account withdrawal rules for 2020 only. 

The CARES Act permits you to withdraw up to $100,000 from your IRA, 401(k), or other tax-qualified retirement plans during 2020 without paying the 10% penalty. But, to be penalty-free, the withdrawal must be because: 

  • You or an immediate family member get diagnosed with COVID-19  
  • You experience adverse financial consequences because you were quarantined, furloughed, laid off, or forced to reduce work hours due to COVID-19 
  • It was impossible to work because lack of child care due to COVID-19 and experience adverse financial consequences as a result, or 
  • You own or operate a business that closed or reduced operating hours due to COVID-19. 

You have three years to pay the regular income tax on such withdrawals. But, if you pay the withdrawal back within three years, you don’t have to pay any tax on it. 

Can you take back an IRA contribution you made this year? 

Yes. You can take back any contributions you made to your IRA during 2020. It’ll be tax-free if you take the money back before April 15, 2021. But you may not claim an IRA deduction on your 2020 taxes. 

Also, you must withdraw any interest or other income your 2020 IRA contributions earned. You have to report this amount as income and pay regular income tax on it (no penalty tax) for 2020. 

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Business Insights and Ideas does not constitute professional tax or financial advice. You should contact your own tax or financial professional to discuss your situation..