June 2009 News Update

The “What Ifs” of an Economic Downturn

There can be a tax impact to events such as job loss, debt forgiveness or tapping a retirement fund. If your income decreased, you may be newly eligible for certain tax credits, such as the Earned Income Tax Credit. Most importantly, if you believe you may have trouble paying your tax bill, contact the IRS immediately, as there are steps they can take to help ease the burden. You also should file a tax return even if you are unable to pay so you can avoid additional penalties.

Here are some “What if” scenarios and the possible tax impact:

What if I lose my job?

The loss of a job may create new tax issues. 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 at tax time. Public assistance and food stamps are not taxable. The IRS has updated a helpful publication which lists a number of job-loss related tax issues. For more information, see Publication 4128, Tax Impact of Job Loss.

What if I receive unemployment compensation?

Unemployment compensation you received under the unemployment compensation laws of the United States or of a state must be included in your income. It is taxable income. If you received unemployment compensation, you should receive Form 1099-G showing the amount you were paid and any federal income tax you elected to have withheld. For more information, see Publication 525, Taxable and Nontaxable Income.

Note: The American Recovery and Reinvestment Act temporarily will change the taxation of unemployment benefits for the 2009 tax year only. Under the new economic stimulus law, the first $2,400 of unemployment benefits received in 2009 will not be subject to federal taxes. The exemption will be reflected on those tax returns filed in 2010.

What if I lose my home through foreclosure?

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. This exception does not apply to second homes or vacation homes. In some cases, you may be able to file an amended tax return for previous tax years. For more information, see The Mortgage Forgiveness Debt Relief Act and Debt Cancellation.

What if I can’t pay my taxes?

Don’t panic. If you cannot pay the full amount of taxes you owe by the April deadline, 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 at 1-800-829-1040. 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. However, the agency is unable to waive interest charges which accrue on unpaid tax bills. For more information, see The Collection Process and Tax Payment Options. The Form 1040 Instructions also provide guidance on filing and paying your taxes.

What if I withdraw money from my IRA?

Generally, early withdrawal from an Individual Retirement Account (IRA) prior to age 591/2 is subject to being included in gross income plus a 10 percent additional tax penalty. There are exceptions to the 10 percent penalty, such as using IRA funds to pay your medical insurance premium after a job loss. For more information, see Publication 590, Individual Retirement Accounts.