The Color of Money: Now's the Time to Prepare for Next Year's Tax Returns

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By Michelle Singletary
Thursday, September 24, 2009

If you've been pounded by the recession, I imagine the last thing you want to think about is your tax situation.

But you'd better be thinking about it, because you don't want to get clobbered come April. The Internal Revenue Service has put together a helpful list of questions and answers for people in financial trouble. You can see the full list of questions by going to and typing "The What Ifs of an Economic Downturn" into the search field. For example, what if you lose your job and receive a lump-sum severance? Do you have to pay taxes on that money?

Of course you do. What if you are paid for accumulated sick leave and unused vacation time? Also taxable.

It's important that you know this so you can set aside enough money to pay these taxes next year. However, if you receive public assistance and food stamps, those entitlements are not taxable.

What about unemployment benefits?

Unemployment benefits vary, depending on where you live, but the average is $305 a week. So you can imagine people don't want to get taxed on that puny amount. Normally, unemployment compensation is taxable. And some states also tax benefits, according to the Department of Labor. Yet, thanks to the American Recovery and Reinvestment Act, the first $2,400 of unemployment benefits is exempt from federal taxation -- but only for the 2009 tax year.

If you are married, the exclusion applies to each spouse, separately. So if both of you are receiving unemployment benefits, you each may exclude the first $2,400 of benefits you receive.

Unemployed workers can opt to have income tax withheld from their benefit payments. If you think you may owe, it's probably a good idea to do this to avoid coming up short next April or worse, being hit with a penalty because you paid too little tax during the year. If you choose to have taxes taken out, you'll have a flat 10 percent withheld. Use IRS form W-4V "Voluntary Withholding Request" to withhold money from your unemployment benefit.

Earlier this year, Rep. John M. McHugh (R-N.Y.) introduced legislation that would suspend the taxation of unemployment compensation for two years. This bill is in the first step of the legislative process, and McHugh has since resigned his seat to become secretary of the Army, but the measure still deserves a thorough debate given the small weekly unemployment checks that people get.

If you lose your job, what expenses, if any, can be deducted? You may be able to claim certain expenses incurred while looking for a job, including r?sum? and outplacement agency fees.

If you are unemployed, you might now qualify for the earned-income tax credit, or EITC, which is meant for low- to moderate-income working individuals and families. As a refundable credit, it means you can get money back even if you owe no tax or the credit is more than the amount of tax owed.

The EITC can reduce your taxes, and that can free up more needed funds. You also may be eligible for a similar credit on your state income tax return. Twenty-two states offer such a credit, according to the IRS. Go to and search for "States and Local Governments With Earned Income Tax Credit" to check whether your state offers this tax benefit.

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