Tax Consequences of Losing Your Job

The tax consequences of losing your job can be overwhelming at an already stressful time. However, knowing what those tax issues are, regardless of how many issues are involved, is key. How you react can profoundly impact your taxes and finances. The following are typical issues related to taxes and loss of employment:

Tax Consequences to be Aware Of When You Lose Your Job

Severance Pay

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.

Unemployment Compensation

If you do not find another job right away, you generally qualify for unemployment compensation. Unemployment benefits are taxable for federal purposes and may or may not be taxable by your state of residence. This includes both the regular benefits you receive from your state unemployment department and the enhanced unemployment payments during the COVID-19 emergency. To minimize the tax you may owe when you file your 2020 tax return, request federal income tax withholding. You can request 10% of the unemployment benefit amount be withheld – which is enough to cover you. Do that by submitting a Form W-4V (Voluntary Withholding Request) to your state’s unemployment office.

Tax Consequences of Losing Health Insurance

The tax consequences of losing your job (and therefore health insurance) are often the most challenging for people. If you had health insurance through your employer’s group health coverage plan, you will need to determine your available options. This may be 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.

Types of Health Insurance Coverage

• COBRA Coverage –
  The Consolidated Omnibus Budget Reconciliation Act (COBRA) requires continuation coverage to be offered to covered employees and family when group health coverage would otherwise be lost. This includes employees, their spouses, former spouses, and dependent children. COBRA continuation coverage is often more expensive than what employees pay for group health coverage. This is because the employer usually pays part of the cost of employees’ coverage. Generally COBRA only applies to private-sector employers with 20 or more employees. Also 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 outside of the normal enrollment window. Often this purchase takes place through a government health insurance marketplace. In addition, depending upon your income for the year, you may qualify for the premium tax credit. This credit would be for the part of the year when you don’t have insurance coverage through your employer. The credit helps pay for additional cost of 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, once employed again, you should also advise the Marketplace. This way, the appropriate adjustments 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. 

Additional Tax Impacts of Losing Your Job

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. This means only 80% of the funds will be available to roll over. The remaining 20% will end up being taxable unless you can make up the difference with other funds.

If 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.

However, if you are tempted to not 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. These distributions should not exceed $100,000 from January 1, 2020 to December 31, 2020. These distributions are penalty-free; they are taxed over three years and can be redeposited to an IRA or qualified plan within three years.

Tax Consequences If You Have to Sell Your Home / Relocate

Home Sale

The tax consequences of losing your job and needing to sell your home relate to how long you’ve lived in the home. If you 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. If married, you can exclude up to $500,000. This is because you and your spouse both 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. The IRS has information directly related to tax consequences of losing your job. 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 at 360-778-2901.