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Recently laid off? Here’s how to navigate your tax situation moving forward
Tax News
5 minutes
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With so many companies announcing workforce reductions (read: business speak for layoff), we want to reach out and first say — we’re so sorry if you or someone you know has been impacted. Layoffs are not supposed to be normal. Somehow, 2022 has become the year we’ve normalized a disruptive and often devastating life event for thousands of gainfully employed people.


After a layoff, there could be a lot of items to work through on your to-do list, but you shouldn’t have to worry about taxes — we have you covered. While it can be stressful, we want to provide some help (just a little) with some tax tips and things to consider as you move through this difficult time.


TL;DR:

  • Income from a severance package is taxed similarly to paychecks, regardless of the payment schedule. Consider holding on to your stocks for at least a year to avoid short-term gains taxation.
  • Unemployment compensation — It could be taxable income if you’re planning on collecting.
  • If you’re taking on gig or freelance work, make sure you set aside some of your earnings to pay the IRS (quarterly or at tax time).
  • A reduction in pay could mean a bigger tax break next year.
  • You may be eligible to withdraw from your retirement savings (and, in some instances, tax-free).


Did you get a severance package?

Severance packages are different for everyone and depend on your position and time at the company. You can get compensated your regular salary for an extended period, plus any vacation hours accumulated, but you will be taxed similar to how you’re taxed on regular income.


You may get paid out in a lump sum or receive payments over time, but it’s all taxed the same. If you chose the payments option and they overlap with income from a new job, consider changing your withholdings on your W-4. If this happens, consider increasing your pre-tax contributions to your 401K or HSA; you can offset some of your taxable income and stay out of a higher tax bracket, saving you money on your taxes.

If you hold stocks from the company, you can hold them without tax implications, but if you sell them, you will be taxed. Consider holding them for more than one year to reduce the taxes you owe. Stocks held for a year or longer are taxed as long-term capital gain tax rates, which are lower than short-term capital gains rates.


What are new taxes to watch out for?


Unemployment compensation

If you can’t find a new job immediately, that’s okay — you may qualify for unemployment income from your state. FYI — You might have heard that some unemployment income is not taxable, but that was true for tax returns filed for the 2020 year, and those rules no longer apply.


Even though unemployment income is taxable on your federal tax return, your state may not impose additional unemployment taxes — every state has different rules. When you apply for unemployment, you may be given the option to deduct all the necessary taxes from every distribution. If you do this, you won’t have to think about the taxes come filing season.


Gig and freelance work

If you decide to work a gig job like an Uber driver — remember you are your own employer. You will be responsible for paying your taxes either quarterly or annually, but it is no longer automatically taken out of your paycheck.


The same applies if you start freelancing as a consultant or a creator. You can form an LLC, which could change how much you are taxed, but a single-member LLC is taxed the same as an individual. An LLC of two or more members is considered a partnership or a corporation, but this option may be a bit more complex for a first-time business owner so we would recommend talking to a tax advisor about the federal and state tax implications.


What are some tax benefits and unintended consequences?


Tax credits

Good news — less income means you may now qualify for certain tax credits, such as the Earned Income Tax Credit (EITC) and the Additional Child Tax Credit (ACTC). For example, a single filer with one child who has earned less than $43,492 with no more than $10,300 in investment income may qualify for an EITC of $3,733 for 2022.


Unemployment income isn’t considered earned income — if you have more unemployment income than W-2 income, it could be a benefit when it’s time to calculate your tax liability.


Higher refund

Another unintended benefit of being laid off is that you may receive a higher tax refund. Suppose it takes you a little longer than expected to find a job, and your income is drastically lower than you were previously making. In that case, you may fall into a lower tax bracket at the federal and state level. The money you’ve already set aside (through payroll deductions) will be greater than what you actually owe — this means a bigger refund.


Do you need cash now?


401K hardship withdrawals

If you encounter an immediate and heavy financial burden, you may qualify for a hardship distribution from your IRA or 401k retirement plan. A hardship distribution sounds like it would only be something negative, but there are events that these distributions cover that aren’t all bad.


A retirement distribution can be handy if you’re considering a new career path after a layoff. You may be eligible for a distribution from an IRA to pay for qualified higher education expenses. Also, if you need to cover costs related to the birth of a child, a hardship distribution can put your mind at ease as you grow your family.

Certain withdrawals, like medical care expenses, will allow you to take out money without paying the 10% withdrawal penalty if you are under 59 ½, but you still need to pay taxes on the withdrawal.


Being laid off can be scary, but having a better understanding of what could come next can help you feel confident as you move forward on your professional journey. We hope this time of transition is brief and that understanding your tax liability is the easiest part of this difficult time in your life.


This content is provided for informational purposes only and should not be construed as tax, legal, financial, or other professional advice. Rules and regulations vary by location and are subject to change, so please consult with an expert if you need specific advice.

Posted by:
april
Content Team
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