Lost your job?  Here’s how it can affect your taxes

What happens to your taxes when you lose your job?

Losing your job often means you have a lower income during the year, which can not only lower your taxes, but it may even allow you to qualify for certain tax credits that could result in a bigger refund. On the other hand, if you receive a lump sum severance, especially late in the year, you may have greater income than normal, which may affect credit qualification.

You must report your unemployment compensation on your tax return. The agency paying you usually doesn't withhold income taxes from your unemployment benefits, but you can ask them to.

Also, if you decide to work for yourself or take a gig, like Lyft or Uber, be prepared to make estimated tax payments throughout the year to avoid IRS penalties (more on that later).

Do you need to file a tax return if you lost your job?

It depends on how much income you earned for the tax year. If you earned more than the minimum required to file for your filing status ($16,100 if single and under 65, $18,150 if single and 65 or older, and $32,200 — may be greater depending on your age — if married filing jointly), you’ll still be required to file a tax return if you lost your job.

If you earned less than the minimum threshold for your age and filing status, you are not required to file, but it may still be in your best interest to do so. As previously mentioned, you may qualify for credits that could result in a refund. The IRS will only issue a refund if you file.

Is unemployment compensation taxable?

Yes, unemployment compensation is taxable. The IRS considers unemployment compensation to be regular income, and taxes it as such. Most states tax it as regular income, too.

How do you report unemployment benefits on your tax return?

Report unemployment benefits on Schedule 1 of your Form 1040, U.S. Individual Income Tax Return.

You can find the information you need on Form 1099-G, Certain Government Payments, which your state’s unemployment agency will send you. If you do not receive Form 1099-G, you must still report your unemployment benefits, and you can usually find the necessary information on your state’s online unemployment portal.

Is severance pay taxable? 

Yes, severance pay is taxable. Just like unemployment compensation, the IRS sees severance pay as regular, taxable income. In most cases, your previous employer will withhold taxes from your severance pay, so you likely won’t have to worry about a large tax bill later.

Can losing your job lower your tax bill?

Yes, losing your job can lower your tax because it can lower your income. Having less income may also qualify you for tax credits that could result in a refund. Your income can, however, increase if you receive significant severance pay that may disqualify you from certain credits.

Can you qualify for tax credits after losing your job?

Yes, if losing your job lowers your income to meet the IRS’s threshold limits, you may qualify for certain tax credits, like:

• The EITC (Earned Income Tax Credit) if you earned income for part of the year
• The CTC (Child Tax Credit) if you have a qualifying child
• The Daycare Credit (officially, the Child and Dependent Care Credit) if you paid for childcare when you worked or while you looked for work
• The Saver’s Credit if you contributed to a qualified retirement account
• The Premium Tax Credit if you bought insurance through the Marketplace

Not only could these credits lower your tax, but the EITC and the Premium Tax Credit are also fully refundable, and the CTC is partially refundable. That means that if you don’t owe tax, you could get the full EITC and Premium Tax Credit back as a refund, and part of the CTC back as well.

What happens if you take money from your 401(k) or IRA after losing your job?

If you take money from your 401(k) or IRA after losing your job, you’ll be required to pay your regular tax rate (if you made pre-tax payments) plus a 10% early withdrawal penalty, unless you qualify for an exception. You may qualify for an exception to the 10% penalty if you are 55 or older the year you lose your job (only if you have a 401(k)), have certain medical expenses, a federal disaster, or a permanent disability, plus some other circumstances.

It’s also important to note that if you take a cash payout, your employer will typically hold 20% of the balance back for federal tax. And, if you have an outstanding loan against your 401(k), you must repay it in full when you leave your job.

What if you start a side gig or become self-employed after losing your job?

If you start a side gig or become self-employed after losing your job, the IRS will require you to make estimated quarterly tax payments on your business net income to stay on top of your income tax and self-employment tax throughout the year.

Starting a side gig or becoming self-employed could also lower your state unemployment benefits, or disqualify you from unemployment altogether if you make more than your benefit week by week.  

What if you cannot afford to pay your tax bill after losing your job? 

If you cannot afford to pay your tax bill after losing your job, the most important thing is to file on time and pay what you can. From there, you may have some options, including:

• Asking for a payment plan: The IRS may grant you a short-term extension if you need more time to pay, or an installment agreement if you need to make smaller payments over time.
• Applying for “Currently Not Collectible” (CNC) Status: If paying for your tax bill would interfere with your ability to pay basic living expenses, like housing or food, the IRS may agree to pause its efforts to collect what you owe.
• Asking for an Offer in Compromise (OIC): If you meet strict qualifications, the IRS may agree to allow you to settle your tax bill for less than you owe.

Whether you have questions or concerns about how the IRS taxes unemployment benefits, or you need help paying tax you owe after losing your job, your local Jackson Hewitt Tax Pro is here to help. Find tax services near you, then walk in or book now. And, good luck out there!