This article was last updated on March 30
Despite a strengthening economy many low- and middle-income families are struggling to make ends meet and the last thing these families want to think about is taxes. However, it is precisely at the this time, with all the government stimulus payments on offer covering unemployment to housing that people need to realize what tax breaks and deductions they are entitled to and what tax traps they need to avoid. These include:
Job Loss. Severance pay and unemployment compensation are taxable. Payments for any accumulated vacation or sick time also are taxable. You should ensure that enough taxes are withheld from these payments or make estimated tax payments to avoid a big bill when your taxes are due in the subsequent year. On the flip side, you may be able to deduct certain expenses you incur while looking for a new job, even if you do not get a new job. Expenses may include travel, resume and outplacement agency fees. Moving costs for a new job at least 50 miles away from your home may also be deductible.
Employer 401K plans: If you lose your job or your employer goes under you still have to abide by the tax rules related to IRA and 401K plans. Generally speaking, if you withdraw the funds before you reach eligible age, and do not roll it over into another qualified retirement plan or Individual Retirement Account (IRA) within 60 days, that amount will be taxable income in the year in which it is withdrawn. You may also have to pay an additional 10% tax on those early distributions. To avoid any additional taxes or penalties make sure you “rollover” your entire 401K into another qualified retirement plan or traditional IRA within 60 days.
Foreclosure and Home Loss: Normally, mortgage debt owed to a financial institution that is cancelled or forgiven (e.g. in a short sale) is taxable. However, under the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers generally can exclude income from the discharge of debt on their principal residence or mortgage restructuring. As an example suppose you borrow $300,000 to purchase a home and default on the loan after paying back $50,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $250,000, which generally is taxable income to you. However, under the new forgiveness debt relief act, you will not have to pay tax on this amount. This exception does not apply to second homes, vacation homes or credit cards. Further, personal losses from the sale or foreclosure of personal property are not deductible.
Tax Hardship: If you cannot pay your taxes by the April 15 deadline, don’t panic. You should still file your return by the deadline and pay as much as you can to avoid penalties and interest. You also should contact the IRS to discuss your payment options. The agency may be able to provide some relief such as a short-term extension to pay, an installment agreement or an offer in compromise. In some cases, the agency may be able to waive penalties. If you can’t resolve your tax problem with the IRS then contact the Taxpayer Advocate Service (TAS), an independent organization within the IRS, whose employees assist taxpayers experiencing economic harm or who are seeking help in resolving tax problems that have not been resolved through normal channels.
Stimulus Tax Rebate: If you had a change in income, a birth or adoption or failed to receive the stimulus payment in 2008, you may be eligible to receive the recovery rebate credit. The maximum credit is $1,200 for a married couple who earn less than $150,000. There also is a $300 credit for each qualifying child age 16 and younger. The recovery rebate credit will add to the amount of your tax refund or lowers the amount of taxes owed.
The full tax impact of a job loss, debt forgiveness and other items discussed here depend on your individual facts and circumstances. Always do you own research and refer to the IRS website for more information.
~ Updates & Taxes on the 2009-2010 Economic Stimulus Credits and Payments
~ Unemployment Health Benefit Extensions
~ Food Stamp Stimulus Payment Boost
~ No Second or New Economic Stimulus Package in 2009. But More than Likely in 2010 or 2011.