If you're unemployed, you've got a lot of company out there. AND, there are some tax traps that could make your financial situation a lot worse. Avoid these common tax problems now!
Tax Trap #1: Unemployment Income isn't taxable. Sorry, the tax man does wants a cut of the action even when you're unemployed. The easiest way to handle the taxes is to have them withheld just like a paycheck. Tax Trap #2: Killing Your Golden Goose When You Raid Retirement Accounts. The last accounts you want to tap are your retirement accounts for several reasons. Since the amount you take out is taxable, the IRS requires that 20% be withheld to cover the taxes.So, if you request $10,000, you're only going to get $8,000. Since the $10,000 would be added to any other income you have for the year, you may be pushed into the next tax bracket and the $2,000 may not even be enough. PLUS, there will be 10% penalty that can't be reduced by any other credits.Your state will tax the income and may also charge penalties for withdrawing early. Tax Trap #3: IRAs can cover certain expenses such as re-training expenses paid directly to a qualified educational institution, health insurance premiums or even early retirement, BUT, you have to handle the withdrawals exactly right or you'll be socked with taxes. Check with your tax preparer and/or financial advisor. Tax Trap #4: Debt Settlements are taxable unless you fall into certain categories. So, if you have a $10,000 balance and the creditor takes $5,000 and call it paid off, you'll receive a 1099-C for the amount of debt that was canceled. Be sure to take this document to your tax preparer. There are some special rules for debt that is canceled through foreclosure. Debt discharged through bankruptcy are not taxable. Tax Trap #5: 401(k) Loans are taxable if you leave your job (for any reason). If you borrow from your 401(k) and are laid off or leave for any reason including disability, your loan becomes due immediately. If you are unable to pay it back, it will be considered a distribution and you will be taxed on it and pay the 10% penalty. However, you would have received the entire amount requested with no taxes withheld like the above example. Therefore, you will have to come up with all the taxes and the penalty on your own. It may take a couple of years for them to actually catch up to you and the IRS will add taxes and penalties in the meantime.
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Before you start taking money out of accounts, meet with your tax preparer and do some tax planning to make sure you don't cost yourself money in taxes, fees or penalties.
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