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Job loss is difficult, and the tax implications can make it even more challenging

Although unemployment has been holding steady at 3.7%, some industries, particularly technology and media, are still experiencing job losses. If you’re laid off or terminated, taxes are likely not your first concern. However, your new employment situation can have significant tax consequences.

Depending on your circumstances, the tax aspects can be complex, requiring decisions that may affect your tax bill for years to come. Pay attention to these three key areas:

1. Unemployment and Payments from Your Former Employer

Many are surprised to learn that federal unemployment compensation is taxable, though some states exempt it from state tax. Additionally, any accumulated vacation or sick time payments from your former employer are taxable. Severance pay is also taxable and subject to federal income tax withholding, but some elements may receive special tax treatment. For example:

  • Selling stock acquired through an incentive stock option (ISO) may result in part or all of your gain being taxed at lower long-term capital gain rates instead of ordinary income tax rates, depending on meeting a special dual holding period.

  • If you receive a “golden parachute payment,” you may be subject to a 20% excise tax on the portion treated as an “excess parachute payment,” along with ordinary income tax.

  • Job placement assistance provided by your former employer is usually tax-free unless you had the option to receive cash instead.

2. Health Insurance Costs

Under COBRA rules, employers must generally provide continuation coverage to terminated employees and their families. While COBRA coverage is often expensive, premiums paid for medical insurance are eligible medical expenses for tax purposes and deductible if you itemize and your total medical expenses exceed 7.5% of your adjusted gross income. If your former employer pays part of your medical coverage after termination, that benefit is not taxable.

3. Retirement Plan Balance

If your employment is terminated, you may need tax planning advice regarding your retirement plan balance. Often, a direct, tax-free rollover to an IRA is the best option. You might also leave the account with your former employer’s 401(k) plan or transfer the money to a new employer’s plan if you get a new job. If you're under 59½ and make withdrawals to supplement missing income, you may face an additional 10% penalty tax unless you qualify for an exception.

Distributions of employer securities in a lump sum are taxed under lump-sum rules, but “net unrealized appreciation” in the stock value isn’t taxed until the securities are sold.

Additionally, any loans from your former employer’s retirement plan, such as a 401(k)-plan loan, may need to be repaid immediately or within a specified period. If not repaid, they may be treated as a taxable deemed distribution.

Contact Us:

For assistance navigating these tax implications during your transition, contact us. We can help you determine the best path forward by  scheduling a meeting with your VAAS Tax Consultant. We look forward to working with you.


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