By Michael S. Rosenwald
Washington Post Staff Writer
Sunday, February 15, 2009
In 2008, the recession set in. Millions of people lost their jobs. Many millions more lost significant sums of money in stocks or mutual funds. People lost homes -- their primary residences, their places on the beach, or both.
For many, 2008 was a lousy year. And now the tax man cometh. In certain situations he bringeth bad tax news to further muddle crummy economic circumstances. In other cases, the tax man provides some relief. It can all be very confusing.
"The important thing I would say is for people not to lose their heads over all of this," said Jackie Perlman, analyst at the Tax Institute at H&R Block. "Make sure you know the laws. If there was a dramatic change in the lifestyle you might want to speak to a tax professional."
Below, we have presented some common situations that emerged from the recession and what the tax implications are for each. For more information, go to http://www.irs.gov and search for "The 'What Ifs' of an Economic Downturn."You lost money in the stock market.
Join the club. The Dow lost 34 percent in 2008, and the S&P 500 lost 38 percent. Stockholders got out of the market, particularly mutual funds, in record numbers. Many people lost a lot of money, which is never amusing, but there is an upside come tax season. The upside is: Write it off!
Let's say you lost $50,000 on XYZ Corp. If you sold the shares at a loss before Jan. 1, you are in a good position. You can use $3,000 of that as a capital loss to reduce your taxable income. And you can continue to draw $3,000 a year off the initial $50,000 until that number reaches zero.
"It's terrific," said Bill Smith, director of the national tax office at CBIZ MHM. "You can dribble down your $3,000 a year."
Another way this $50,000 loss can help you is if you had stocks that you sold at a gain. (Yes, some stocks did go up last year, though you really had to hunt for them.) In that case, let's say you had a $10,000 gain on LMNOP Corp., as well as that $50,000 loss on XYZ. You can deduct $10,000 of your loss on XYZ from your capital gain on LMNOP. And you can then use an additional $3,000 from your loss on XYZ as a deduction from other taxable income. That means you would be able to sell shares at a gain with no tax consequence, and you would now have $37,000 in deductions left over to carry forward until they're gone.
You lost money in a stock or a mutual fund, but didn't sell the position at a loss before Jan. 1.
A loss has to be realized before there are tax benefits. But it's never too early to think about taxes, so talk to your tax professional now so you don't miss out on potential benefits next tax season.
You think you are crafty, selling a stock at a loss on Dec. 31 and then buying it again just after the new year.
Think again. "You can't do that," Smith said. You cannot claim a loss if you purchase the same stock within 30 days before or after you sold the position. "They don't let you write off the loss if you are not really changing position on the stock," Smith said. This is called the "wash sale rule." Be aware.
You lost your job.
There are many tax implications in this situation.
Generally, severance pay and unemployment compensation are taxable, though under stimulus proposals working their way through Congress, some of that could change in 2009. Also taxable: any accumulated sick or vacation pay you are entitled to.
"You should ensure that enough taxes are withheld from these payments or make estimated payments," the IRS recently warned workers in a publication called "Tax Impact of Job Loss."
If you take out cash from your pension plan, that's taxable and a penalty would apply unless you transfer it to, say, an IRA.
You can receive financial help from a family member or friend without paying income taxes on it. The giver faces no tax consequences up to $12,000.
On the upside, certain job search related expenses are tax deductible, including travel, résumé preparation and outplacement agency fees. If you move more than 50 miles for a new job, those expenses can be deductible.
You borrowed from your 401(k) plan.
This can be tricky. The important thing to know is that if you don't pay back the loan on time, you are subject to income taxes and a 10 percent early withdrawal penalty.
If you cashed out a life insurance policy, check with the policy holder and an accountant.
You have a big tax bill and no money to pay it.
For this quandary, let's turn straight to the IRS Web site for an answer: "Don't panic. If you cannot pay the full amount of taxes you owe by the April deadline, 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."