2021 taxes will look different for many Americans. Suppose you are among the millions of Americans who suddenly became unemployed during the coronavirus pandemic. In that case, you are probably wondering how unemployment benefits and severance pay will impact your tax status. Getting laid off from your job presents a host of new challenges and concerns, from how to pay the bills and put food on the table to what to do if an emergency occurs. The last thing you need to add to your worries at this time is how the job loss will impact your taxes. As with anything, knowledge is power. Learning how layoffs and severance pay can affect your taxes arms you with the ability to minimize the tax burden on you and possibly even avail you of some extra tax benefits. The following is a brief guide regarding the tax implications of unemployment and severance pay.
PART I: How Does Severance Pay Affect Taxes?
Are Severance Benefits Taxable?
Severance benefits and payouts for unused personal time are treated the same as wages. This means that they are subject to Social Security and Medicare withholding and must be claimed as income on your taxes.
Manage Your Tax Liability With Scott Boyar, Tax Accountant Charlotte NC:
A lump-sum severance payout, especially if you have been with the company for a long time, can create a significant tax liability since it will likely place you into a much higher tax bracket. There are, however, several ways in which you can minimize the burden, including:
Contribute to a retirement account.
Adding money to your individual retirement account or 401(k) will help you reduce your immediate tax liability while setting aside money for the future. Annual contributions to IRA accounts are capped at $6,000 for 2019 and 2020. You can contribute an additional $1,000 if you are over 50. Annual contributions to 401(k) retirement accounts are capped at $19,000 for 2019. This increases to $19,500 for 2020. Individuals over 50 can contribute an additional $6,000 for 2019 and $6,500 for 2020.
Save it for health care expenses.
If you have a high-deductible health insurance plan or anticipate health care expenses in the near future, you can set aside a portion of your severance in a health care savings account.
Contribute to a college savings account.
You can help your child or a niece or nephew with future college expenses by opening a 529 college savings account. You can even set up a 529 account and then use the funds to pay off up to $10,000 of your college debt.
Divide severance into multiple payments.
Severance payments are taxed in the year that they are paid out. You can spread out the tax liability over two tax years by strategically dividing your severance payout over separate calendar years.
PART II: How Unemployment Affects Taxes
Are Unemployment Benefits Taxable?
Unemployment benefits are also taxable. While it is possible to wait until you file your taxes to pay, this can result in a hefty tax bill that can be difficult to manage, especially if your financial situation does not improve quickly. Typically, the best options are to request that the taxes be automatically withheld from each payment or to pay estimated quarterly taxes. A Charlotte CPA can also advise you on other tax implications that can arise with a change in financial status. For example, a decrease in income may mean that you qualify for additional tax credits and deductions, such as the earned income tax credit or the child and dependent care credit. Your change in financial status may also qualify you for additional local, state, and federal benefits. These programs can help reduce the cost of everything from housing and food to transportation and utilities. The majority of these benefits are not taxable.
Many Americans are turning to non-traditional types of employment to make ends meet following a layoff. These gig jobs, such as driving for a ride-sharing company or an online grocery delivery service, also create significant tax implications. For example, self-employed individuals and freelancers are responsible for paying self-employment taxes. These are the taxes for Social Security and Medicare that would generally be withheld and funded by an employer. A Charlotte CPA can also advise you if any of the expenses related to your self-employment are tax-deductible.
What Should I Do If I Have Not Filed My 2019 Taxes?
Although the federal tax filing and payment deadline have been extended to July 15, 2020, you should file as soon as possible if you are anticipating a refund so that you have the money in your pocket as quickly as possible.
Scott Boyar, CPA: Trusted Tax Advisor Charlotte, NC
Since each person’s financial situation is unique and the tax laws are constantly changing, it is essential to consult a Charlotte CPA for advice. Scott Boyar is a Certified Financial Planner™ and CPA licensed in North Carolina and New York. Scott has the training and experience to help you navigate your new financial situation. Call or contact us online for more information or to schedule a consultation.