Posted by Income Taxes and Bookkeeping LLC

5 Tax Tips for the Unemployed

5 Tax Tips for the Unemployed

April is usually the cruelest month, especially for the unemployed. Say you've been unemployed for months or even a year, waiting in line at every busy job fair and applying to every job board. The only money coming in is government unemployment benefits, a fraction of your regular salary and not enough to cover your mortgage, credit card bill, and groceries. But comes April 15, and the Internal Revenue Service (IRS) ends up kicking you while you're still on the ground.

Yes, unemployed people must declare and pay income tax. But there is good news. If you are experienced with tax deductions and credits, you can significantly reduce your tax burden and even escape the taxman's grasp until you get back on a payroll. So, what are the tax tips for the unemployed that you need to know?

Unemployment Benefits are Taxable

Yes, it sounds cruel and unusual, but any unemployment benefits you receive from the U.S. government (whether federal or state) are also subject to taxation by the U.S. government. You still have to pay taxes for unemployment benefits through a federal disaster relief program. If this is new to you, you are not alone. According to a recent survey, almost 40% of taxpayers had no idea that unemployment benefits were taxable.

If you receive unemployment benefits, the IRS will file Form 1099-G a few months before taxes are due. The form will show you exactly how much you earned from unemployment benefits. You are responsible for entering this amount on the appropriate line of income tax form 1040.

To avoid the surprise of paying all your unemployment compensation taxes dues in April, you can choose to withhold unemployment benefit taxes throughout the year. Complete Form W-4V, and return it to the office that sent you the benefits. After that, the government will withhold 10% of each check.

Please note that unemployment benefits paid through the employer's private supplementary unemployment fund or union unemployment fund are taxed differently from government unemployment compensation.

You can deduct job search expenses.

Finding a job can be a full-time job in a tight job market. First, you need to craft the perfect resume, which often requires the paid services of a consultant. After which, you need to get that resume in the hands of the right people, which may require a paying member on a particular job search and networking site. What if the best job prospect was in another state? You may need to travel to the state for the first, second, and third interviews. 

The good thing is that you can deduct some of your job search expenses as an itemized deduction. The Internal Revenue Service (IRS) classified job search expenses as miscellaneous deductions, meaning they are deductible only after exceeding 2% of adjusted gross income. With your normal salary, it would be difficult. But if you've been unemployed for most of the tax year, it doesn't take long to top 2%.

The hidden gem of job search deductions is travel expenses. What happens if there are no jobs in your area? If you travel at least 50 miles from your old job location to find work, you may be able to deduct some of your moving expenses. We say "may be able" because there are qualifiers. Once you have found employment in your new location, you must remain employed as a full-time worker for at least 39 weeks over the next 12 months to claim relocation expenses. The best thing about moving expenses is that you don't have to deduct any deductions to claim them, and you don't have to surpass a minimum percentage of your gross income.

The not so good news is that you can't deduct the cost of a new dress or haircut for that job interview.

You can deduct certain medical expenses.

For many Americans, unemployment provides a shocking first introduction to the costs and complexity of the healthcare system. Taking health coverage for granted is easy when you have a reasonably paid employee-sponsored health insurance plan. But if you lose your job, COBRA extends your health insurance coverage for a few months, after which you're on your own.

You can deduct any unpaid medical expenses that exceed 7.5% of your adjusted gross income for tax purposes. These limits seem high at first, but consider the medical expenses you can deduct:

  • Co-payments

  • Medical travel (mileage)

  • Out-of-Pocket medical examinations

  • Payments for COBRA insurance or individual insurance

  • Prescribed medications

  • Unreimbursed hospital bills

Suppose you are over 50 and have lost your job primarily due to foreign competition. In that case, you may be eligible for the Health Insurance Tax Credit, which pays up to 72.5% of eligible health insurance premiums. The requirements for these credits are very specific, but if you qualify, it's a tax deduction you can't waive.

Check that you are eligible for the EITC.

The EITC (Earned Income Tax Credit) is a tax exemption for low-income U.S. workers. The value of the EITC depends on your income and the size of your family. For most credits, you can only earn about $15,000, and the EITC is eliminated if your adjusted gross income (AGI) is $50,000 or more.

But here's the tricky part: you need to have the income to qualify for the EITC, and unemployment benefits aren't counted as income when calculating your credit. Therefore, if you have been unemployed for the entire tax year, you may not have enough income to qualify for the EITC. But if you were employed for part of the year or your spouse contributed to your earnings, you may still qualify for the EITC, which has a maximum payment of $5,751 for a family of three or more children. 

Switch from unemployed to self-employed

The recession drove up the unemployment rate and convinced more and more Americans to take matters into their own hands. In 2012, more than 30% of American workers were self-employed, many of them as freelancers, contractors, or consultants. If you file taxes as self-employed and not as unemployed, you may be able to collect additional deductions. Just be sure to follow the Department of Labor rules for applying for unemployment insurance, and you'll be fine.

As a freelancer, you can deduct a portion of all expenses you incur with a home office. Now, it's important to keep in mind that a home office should be more than just a makeshift desk in your bedroom. An IRS-eligible home office must be used "exclusively and regularly" for business purposes, including seeking employment. Once you've established your home office, you can deduct some of the cost of rent, internet and phone services, utilities, property taxes, etc.

Another benefit of being self-employed is deducting the full cost of any health insurance you purchase for yourself or a family member. This is not an itemized deduction and is not limited to a minimum percentage requirement.

Finally, since you are running your own business, you have more freedom to deduct expenses as business expenses. For example, a self-employed person can deduct the mileage driven to serve potential customers. The 2022 mileage deduction rate is 58.5 cents per mile.



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