by Moe Zilla

Created on: February 09, 2008

Unemployment brings a new income status - and a new set of tax regulations. Here's the most important things to remember about filing taxes when unemployed.

First, the bad news.

* Unemployment benefits are taxable. When calculating taxes for the year, unemployment checks are counted as regular income. It's possible to request withholding on unemployment benefits to cover the taxable amount, but many recipients simply opt to receive all the money, and then pay a lump sum later.

* Severance pay is taxable. When an employer offers a severance package, it's still a form of income. In some cases a large severance package can even push an employee into a higher tax bracket (especially if it's received towards the end of the year).

Fortunately, there's also some good news for the unemployed.

* A change in income may push an employee into a lower tax bracket. This means the amount withheld from each paycheck may ultimately have been too high, guaranteeing a large refund when the tax return is filed.

* Health insurance and other medical expenses are deductible (if they exceed 7.5% of adjusted gross income). If any income is earned during the period of unemployment, then "self-employed" status can be invoked to cover additional health expenses. (Unfortunately, if the amount is more than $400, it will also be subject to the hefty self-employment tax.)

* Unemployed status also waives the hefty penalties for withdrawing from IRA and 401(k) plans for certain expenses (including healthcare). And unemployed status also opens a loophole for IRA contributions. Normally IRA contributions aren't tax deductible if an employee is already covered by their employer's retirement plan. Being unemployed for any part of the year opens a window of eligibility.

* Any costs that are related to a job-related move are also deductible

* Job search expenses may also be tax deductible, if they add to up more than 2% of total income. This includes travel expenses when interviewing for a new job, and even education expenses if they're in an employee's current field of employment.

It's challenging to lose a job - but like any major life change, it brings advantages as well as disadvantages.

Learn more about this author, Moe Zilla.
Click here to send this author comments or questions.