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Unemployment Rates Rising Across the Board: Tax Considerations for Recently Unemployed

Considering news that the unemployment rate went up in almost every state during May, or to be more specific, in 48 states plus D.C., there may be no better time to review some tax considerations in the context of losing a job.

Bob D. Scharin, Senior Tax Analyst for the Tax & Accounting business of Thomson Reuters has some great tax tips for couples and families where one of the wage-earning spouses has lost their job. One of the tips was for income tax withholding, which is something that may be often-overlooked because people sometimes don't remember that their withholdings usually anticipate a full year's worth of earnings:

"Reduce income tax withholding.  With only one wage earner in the family, you can have less income tax withheld from your pay.  Before making the change, consider potential increased eligibility for tax deductions and credits that have income phaseouts, as well as the tax effect of any severance payment to your spouse. Also, bear in mind: up to $2,400 of unemployment compensation is tax-free in 2009."

Another tip dealt with the very common question of what to do with a 401(k) account when someone loses their job:

"401(k) accounts.  Should your spouse leave the funds in the 401(k) plan account that's been building for years through his or her former company or roll them into an IRA? Many people keep the money in the 401(k) so they don't have to make new investment decisions, but there are often benefits to rolling it over, though not without possible tax ramifications. Also, if you need to choose between withdrawing some funds from that 401(k) to get cash or reducing future 401(k) contributions to your own plan, keep in mind that the withdrawal could subject you to a 10% additional tax. By reducing your contributions to your plan, you may lose matching contributions from your employer."

While on the subject of unemployment, considering how tough the job market is these days, some people may turn to doing some consulting work or working on temporary projects. Those who do so should keep just keep in mind that this may bring with it more scrutiny (i.e. audits) from our friends over at the IRS, considering that the IRS feels that most tax cheats come from those who are classified as "self-employed". Needless to say, trying to short the IRS on taxes is a very bad idea which can lead to significant civil penalties, or worse, criminal charges in extreme cases.