Being unemployed presents a variety of financial considerations, including potential taxes.
In some cases, federal tax laws could pose new costs to unemployed individuals. But in others, tax provisions could help ease, at least a bit, the financial strains of unemployment.
Pay taxes on unemployment
First, the bad news. Unemployment compensation is taxable income. A few years ago, a small amount of unemployment benefits were exempted from taxation, but that tax break has expired.
You'll get a Form 1099-G that will tell you how much unemployment you must report on that year's tax return. If you opted not to have taxes withheld from unemployment payments or didn't make estimated tax payments on the amount, you'll likely owe the Internal Revenue Service.
Married couples have another option. If your spouse has a job, cover the unemployment taxes by having your husband or wife adjust his or her withholding to cover the taxes due on your benefits.
Check EITC eligibility
The earned income tax credit, or EITC, is a tax break for workers who don't make very much money. Because your overall earnings were reduced by your layoff, you now may be eligible for the EITC.
Unemployment benefits don't count toward EITC eligibility, but if you earned any other income during the year you can use that amount to calculate a possible credit claim. Also, if you are married and your spouse is working, your loss of income may now make your combined earnings eligible for the credit.
Single taxpayers can claim the EITC, but the benefit is greater for workers with dependent children.
Incomes that qualify for EITC for the 2011 tax year
- Earnings of less than $43,998 ($49,078 if married filing jointly) in households with three or more children.
- Earnings of less than $40,964 ($46,044 if married filing jointly) in households with two children.
- Earnings of less than $36,052 ($41,132 if married filing jointly) in households with one child.
- Earnings of less than $13,660 ($18,740 if married filing jointly) in households with no children.
This tax credit also is refundable. This means if you don't owe any taxes, you'll be able to get a refund of the excess EITC amount.
Tap retirement accounts early
In dire situations, you might be tempted to cash out a retirement plan. If you do, be prepared to pay a 10 percent early withdrawal penalty if you are not yet age 59½ and take money out of a traditional IRA or are younger than 55 and take a 401(k) distribution.
The penalty is waived, however, if you use your IRA money to pay for unreimbursed medical expenses that total more than 7.5 percent of your income. Workers who receive unemployment compensation for 12 consecutive weeks can also use money from an IRA, but not a 401(k), to pay for medical insurance.
A hardship withdrawal from a workplace retirement plan is allowed penalty-free if, according to the IRS, the distribution is for "an immediate and heavy financial need." This includes such things as medical expenses, certain educational expenses and payments necessary to prevent eviction from, or foreclosure on, your home.
Remember, however, that even if you're able to avoid an early distribution penalty, you'll still owe taxes on the amounts withdrawn from these retirement accounts.
Look for a job
Hang onto all your job search receipts. Expenses for such things as employment and outplacement agency fees, resume services and job-hunting travel, both in-town and out-of-town trips, can be deducted.
There are, however, limits to job-hunt tax breaks.
You must itemize to claim job-search expenses. These costs are miscellaneous deductions, meaning they and other eligible miscellaneous expenses must amount to more than 2 percent of your adjusted gross income before you can claim them. And your job-hunt expenses must be toward employment in your current professional field.
Start your own business
If some of those job-search expenses were toward investigating a possible business of your own, they count, too. Once you are successful in starting your own company, you can claim additional business tax breaks.
Expenses related to the process of operating your business generally are deductible. Don't forget auto expenses if you use your car for business. Keep thorough records and receipts to document all these new company costs.
If you operate your new business from your residence, you might be able to claim a deduction for your home office.
Health care costs that you as a business owner pay for yourself and your family are deductible.
The IRS is happy to let you deduct eligible business expenses because in the longer term, it's better for everyone. Your entrepreneurial success will not only help boost your personal bottom line, but will also mean more tax money for the U.S. Treasury.
More From Bankrate.com