The Internal Revenue Service recognizes that many people may be having difficult times financially. 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. There are steps we 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 my income declines?
There are many tax credits that are subject to income limitations. If you had a reduction in income this year you may be eligible for some credits or deductions. For example, the Earned Income Tax Credit is available for working families and individuals. Eligibility is determined by income and family size. You must file an income tax return in order to claim EITC. See 1040 Central for more information on EITC, other tax credits and tax law changes.
What if I am searching for a job?
You may be able to deduct certain expenses you incur while looking for a new job, even if you do not get a new job. Expenses may include travel, resume and outplacement agency fees. For more information, see Publication 529, Miscellaneous Deductions . Moving costs for a new job at least 50 miles away from your home may also be deductible.
What if my employer goes out of business or in bankruptcy?
Your employer must provide you with a Form W-2 showing your wages and withholdings for the year by Jan. 31 of the following year. For example, if you were employed during 2009, your employer should provide you with a W-2 for 2009 by Jan. 31, 2010. You should keep up-to-date records or pay stubs until you receive your Form W-2. If your employer or its representatives fails to provide you with a Form W-2, contact the IRS and we can help by providing you with a substitute Form W-2. If your employer is liquidating your 401(k) plan, you have 60 days to roll it over to another qualified retirement plan or IRA. For more information, see Publication 4128, Tax Impact of Job Loss.
What if I close my own business?
If your business is no longer operating, you still are responsible for filing all required tax returns for your business by the due dates. In addition, if you had employees, you must file all required employment tax returns, including Forms 940, 941, 943 or 944. Both business and employment taxes should be paid when due. But, if you are not able to pay in full, contact the IRS immediately to discuss your options. For more information, see Starting, Operating or Closing a Business.
What if I withdraw money from my IRA?
Generally, early withdrawal from an Individual Retirement Account (IRA) prior to age 59½ 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.
What if my 401(k) drops in value?
Generally, you can not claim a capital gains loss on your retirement accounts that already are receiving favorable tax treatment. The only time you would have a loss is when you receive a distribution that had previously been taxed. For more information, see Publication 575, Pension and Annuity Income.
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 sell my home for a loss?
Losses from the sale of personal–use property, such as your home or car, are not deductible. It is not eligible for the capital gains loss of up to $3,000 annually. For more information, see Publication 523, Selling Your Home.
What if my debt is forgiven?
The tax impact of debt forgiveness or cancellation depends on your individual facts and circumstances. Generally, if you borrow money from a commercial lender and the lender later cancels or forgives the debt, you may have to include the cancelled amount in income for tax purposes. The lender is usually required to report the amount of the canceled debt to you and the IRS on a Form 1099-C, Cancellation of Debt. There are several exceptions to the taxability of cancelled debt, such as insolvency or bankruptcy. For more information, see The Mortgage Forgiveness Debt Relief Act and Debt Cancellation.
What if I am insolvent?
A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The forgiven debt may be excluded as income under the "insolvency" exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. If you believe you qualify for any of these exceptions, see the instructions for Form 982. For more information, see highlights of the Mortgage Forgiveness Debt Relief Act.
What if I file for bankruptcy protection?
Debts discharged through bankruptcy are not considered taxable income. If you are an individual debtor who files for bankruptcy under chapter 7 or 11 of the Bankruptcy Code, a separate “estate” is created consisting of property that belonged to you before the filing date. This bankruptcy estate is a new taxable entity, completely separate from you as an individual taxpayer. Please note, however, that some tax debts are not dischargeable in a bankruptcy action. For more information, see Publication 908, Bankruptcy Tax Guide.
What if I can’t pay my taxes?
Don’t panic. If you cannot pay the full amount of taxes you owe, 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 did not receive an economic stimulus payment?
If you had a change in income, a birth or adoption or failed to receive the stimulus payment in 2008, you may be eligible to receive the recovery rebate credit. The maximum credit is $1,200 for a married couple who earn less than $150,000. There also is a $300 credit for each qualifying child age 16 and younger. For more information, see the Recovery Rebate Information Center.
What if there is a federal tax lien on my home?
If there is a federal tax lien on your home, you must satisfy the lien before you can sell or refinance your home. There are a number of options to satisfy the tax lien. Normally, if you have equity in your property, the tax lien is paid (in part or in whole depending on the equity) out of the sales proceeds at the time of closing. If the home is being sold for less than the lien amount, the taxpayer can request the IRS discharge the lien to allow for the completion of the sale. Taxpayers or lenders also can ask that a federal tax lien be made secondary to the lending institution's lien to allow for the refinancing or restructuring of a mortgage. The IRS currently is working to speed requests for discharge or mortgage restructing to assist taxpayers during this economic downturn. For more information, see IRS Speeds Lien Relief for Homeowners Trying to Refinance, Sell or File a Notice of Federal Tax Lien.
What if I can't pay my Installment Agreement?
You have several options available if your ability to pay has changed and you are unable to make payments on your installment agreement or your offer in compromise agreement with the IRS. Call the IRS immediately at 1-800-829-1040. Options could include reducing the monthly payment to reflect your current financial condition. You may be asked to provide proof of changes in your financial situation so have that information available when you call.
For any and all of your tax and finance questions, please check out our website at www.mbtaxpro.com. Happy New Year!
David Bixel, EA
Portland, OR 97210
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