Job search tax planning
With record unemployment you may not be aware of how the tax code can be used to reduce the cost of a job search. Some job search expenses are deducted as a miscellaneous itemized deduction. These deductions are limited, so some of the benefit may be lost. However, by being self-employed during your job hunt, you can convert limited deductions in to fully deductible ones.
Getting tax help is a wise move for job hunters. “Even a little goes a long way, and a quick phone call could save you a lot of money,” says Melissa Labant of the American Institute of CPAs.
The first place many job-hunters look for write-offs is the miscellaneous deduction, which includes unreimbursed employee expenses and applies to the recently unemployed as well. It is the go-to slot for deducting travel, entertainment, subscriptions, business cards and other costs.
There is a problem, however. Permitted expenses are deductible only to the extent that they exceed 2% of a taxpayer’s “adjusted gross income,” which is income minus a few items. On a $100,000 income, that’s $2,000. This can be difficult if you have a working spouse, severance or other income.
There’s another limit, too. Job-hunting expenses can count as miscellaneous deductions only if a taxpayer is looking for work in the same occupation. That rules out write-offs for students looking for a first job, or a machinist who wants to become a screenwriter.
The rule’s boundaries are vague. For instance, if an engineer who managed a couple of people is looking for a pure management job, she could reasonably claim that she was and will remain a manager. But sometimes the IRS takes a hard line on such claims.
Fortunately, there’s a better route for job-seekers who can earn some income: set up a sole-proprietorship business reported on Schedule C of the tax return. Here taxpayers may fully deduct many “ordinary and necessary” costs of doing business.
As a result, deductions for home-office, business-card, travel or résumé-preparation expenses that otherwise would be limited are fully allowed now—as long as the costs are matched against income you’ll claim on Schedule C. And there isn’t a requirement to stick with your former occupation.
For example, if a lawyer wants to become a chef, he can’t claim job-search costs as a miscellaneous deduction. But if he sets up a Schedule C business as a chef and finds a temp job or two, he can deduct his knives and business cards while also looking for a full-time job.
The biggest problem with this strategy is that you need income. The IRS frowns on losses from businesses unless they show a profit in at least three years out of five. This is known as the hobby loss rule. But even a small profit opens the door to many deductions.
Business owners must pay both the employer and employee share of payroll taxes on net income—currently 13.3%—and file quarterly tax returns. “People used to getting a paycheck where taxes are withheld are often shocked by this,” says Ms. Labant of the American Institute of CPAs.
What if you find a full-time job? Nothing prevents a taxpayer from being both an employee and the owner of a Schedule-C business. Many employees have consulting businesses on the side.
One more caveat for job-seekers, and any other taxpayer, for that matter; who plan to take deductions of any type: Get serious about record-keeping. The IRS is a stickler about this.
Now for more specifics on the tax treatment of everything from severance pay to home-office expenses.
Severance pay is taxable, as is accumulated vacation or sick pay, but the former employer is supposed to withhold federal and state taxes. Unemployment pay also is taxable.
Withholding for unemployment isn’t automatic, however, and many taxpayers forget this fact. To avoid getting caught short at tax time, file IRS form W-4V with your state. Tax will be withheld at a flat 10% rate.
Those whose income drops significantly also may be newly eligible for “refundable” credits such as the Earned Income Credit or the Additional Child Credit, which provide a refund even if tax isn’t owed.
If your former employer pays employment- and outplacement-agency fees, they don’t count as income to you. If you pay these expenses, they count as miscellaneous deductions.
There’s good news for people who are between jobs and tap investment funds. Those with taxable incomes of less than $34,500 for single filers or $69,000 for joint filers pay no tax on long-term capital gains or qualified dividends. So if you must tap your accounts, at least you don’t have to pay Uncle Sam.
Many ex-employees make tax-free rollovers of their 401(k) plans into an individual retirement account after they leave a company. But some tuition payments; medical insurance premiums for some unemployed workers; and medical expenses if they are greater than 7.5% of adjusted gross income are exempt from the 10% penalty.
With a Roth IRA, the account owner may withdraw his or her own contribution free of income tax. But the 10% penalty (and exceptions) mentioned earlier applies if the account was converted from a regular IRA within the previous five years. And if you withdraw Roth earnings—as opposed to principal—before age 59½, both income tax and the 10% penalty may apply. Again, keep good records
Unreimbursed medical expenses (which include insurance premiums) are deductible only for those who itemize, and only to the extent that they exceed 7.5% of adjusted gross income (or 10% if you are subject to alternative minimum tax). With income low, it may be easier than usual to get over this limit. For taxpayers who are self-employed, health-insurance premiums may be fully deductible.
Deductions for a home office, including supplies and equipment such as a computer, may get a better break if taken on Schedule C, whereas they will be limited if they qualify as miscellaneous expenses.
To be deductible, a home office usually must be used exclusively and regularly as a principal place of business. (No weekend football-game watching or kids doing homework.) Appropriate services and supplies—business cards, resume preparation, cell phone, professional fees—for the business or the job hunt are often deductible as well.
Equipment, such as a computer, may need to be depreciated over time. If there is personal as well as business use, expenses may have to be allocated between the two.
Finding work, permanent or part-time, often requires prospecting near and far. As with home offices, qualified travel and entertainment deductions often get a better break on Schedule C.
The rules are fuzzy, but job seekers who want to deduct travel would do well to spend more than half their time looking for work while they are traveling. (Travel time also counts as work.) Thus for many, evenings or weekends aren’t part of the equation.
For drivers, the IRS allows 55.5 cents per business mile, or else actual costs such as depreciation, gasoline and maintenance. Taxpayers who want to go the latter route should probably seek expert help, because this quickly gets complicated, especially if there is personal use involved.
What about meals and entertainment? The allowed deduction starts with 50% of their cost, and you should keep excellent records—say, a short note as to what was discussed—in case IRS agents come calling.
Would more education help a job search? For those without a college degree, the most useful tax break is likely to be the American Opportunity Tax Credit, which can be claimed even if you don’t have income.
What about graduate or professional-enrichment courses? At least nine benefits exist, all with different requirements and income limits.
Two of the most commonly used are the Lifetime Learning Credit and the so-called Tuition and Fees Deduction.
Unreimbursed moving expenses may be written off even if a taxpayer doesn’t itemize deductions. But the new job usually has to be at least 50 miles away from the old one.
A taxpayer also must hold a new job for a certain period after a move, which differs depending on whether he or she is an employee or self-employed.