The Tax Effects of Separation Pay and Other Compensation

Mar 15, 2010Mark Oehlert

Well, it’s almost upon us, the IRS tax filing deadline and the IRS tax refund check that soon follows. It’s been a tough year for some folks due to the economy and job market over the past year or so. Allowable tax deductions are a very helpful thing around this time of year. it just makes sense to make sure that all allowable deductions are taken.

Procrastinators will find plenty of reasons to put off filing taxes yet another day, but smart folks will put their nose to the grindstone, wade through all that paperwork, and get all tax forms and supporting documents filed as soon as possible. Rushing through the filing process is only setting the stage for making mistakes and no one wants to make a mistake in filing taxes. with that in mind, be sure and take all allowable deductions related to unemployment. Here’s a few tips.

Unemployment Compensation is Taxable Income

That’s correct. As hard as it is to hear, all those funds that have been received due to job loss, layoffs, or just because a company went out of business and had to let folks go, is indeed considered taxable income. There is a bright side. The American Recovery and Reinvestment Act of 2009 allows for the first two–thousand four–hundred dollars of any 2009 unemployment benefits to be non-taxable.

Married couples filing jointly who have both received unemployment compensation for 2009, each spouse may deduct the two–thousand four–hundred dollars, for a total deduction of four–thousand eight–hundred dollars from their reported unemployment income. The IRS will provide a Form 1099-G which will show exactly how much unemployment compensation was received in 2009. If using eFile, the software will automatically subtract two–thousand four–hundred dollars from the 1099–G form.

Separation Pay and COBRA Health Insurance Coverage

Severance pay or separation compensation is also considered taxable income. Any amounts paid for unused vacation or accumulated sick leave is also taxable income. it makes sense to prearrange for the employer to withhold a sufficient amount from this amount to cover any taxes.

Recent job loss or separation from a company allows for the former employee to provide access to the same health coverage that was provided when employed. This federal law known as COBRA requires former employers to provide the opportunity to be covered under their policy for up to 15 months after separation. The drawback is that the entire premium must be paid, which can be quite expensive.

It may be possible to set up a health savings account rather than pay all those expensive premiums. Contributions into this health savings account are tax deductible and the money from the account may be used to pay for qualified medical expenses tax free. Check with a qualified tax professional or CPA for additional details specific to a particular situation.

The IRS is really out to Help Folks with any Problems

The official IRS website – irs.gov/ is the only IRS website. Don’t be fooled by any other sites claiming to be the official IRS or it’s representatives. These fraudulent websites will appear to be only be a little different from the official IRS website. Fraudulent websites will use irs.com, or the suffixes .org or .net. Identifying the correct, official IRS Website is a key in not getting ripped off.

This information is not intended to be a source of legal advice, and no information in this article should be considered or relied upon as legal, tax or financial advice on any specific matter. never act upon general information on legal, tax or financial matters without seeking legal counsel regarding your particular situation. Check out the IRS website at irs.gov for more information.

Related Articles:

Tax Scams Impersonating the IRS

Top Tips to get a bigger IRS Tax Refund Check

Check Status of IRS Tax Refund

Sources:

efile.com; Unemployment Benefits, Taxes and Job Loss Tax Effects (accessed Mar 15, 2010)

irs.gov; Unemployment Compensation (accessed Mar 15, 2010)