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Struggling taxpayers, part 1: tax issues related to job loss

“You can’t get blood from a stone,” goes the old phrase. Lawyers who are seeking to collect on judgments in favor of their clients know this phrase, and the reality it points to, very well. So, of course, do debt collectors – though those collectors sometimes try to squeeze even when there is nothing there.

In terms of paying taxes, the IRS makes at least some acknowledgement that taxpayers who are struggling financially may have difficulty paying their taxes. In this post, let’s look at some of the scenarios this presents.

Let’s start with job-related issues, which have affected so many people in Southern California and across the country in the wake of the Great Recession.

Job loss, of course, has immediate financial implications for most people. After all, few people have the contingency fund that experts say we should all have. And regardless of how many resources someone has to fall back on, there is often a strong emotional impact on people from job loss of any sort.

But job loss also has tax implications. For one thing, if someone receives severance pay, there are unresolved questions regarding the taxation of that pay. We discussed this issue in our October 13 post.

Generally, however, the IRS considers severance pay to be taxable income. The same is true of unemployment compensation, as well as payouts when a job ends of accumulated sick time or vacation time.

Another common scenario following job loss is being forced to withdraw money prematurely from a retirement account. This naturally raises the issue of the tax treatment of money that is withdrawn from an individual retirement account (IRA).

The IRS generally takes the position that, before the age of 59 ½, withdrawals from an IRA are to be included in a taxpayer’s calculation of gross income. The IRS also seeks to impose a tax penalty of 10 percent for early withdrawal of this type.

To be sure, there are certain exceptions to the penalty provision for early withdrawal. One of those, for example, is when the money is used to pay for health insurance after a job loss.

In short, job loss raises a host of tax-related issues.

Source: IRS.gov, "The 'What Ifs' for Struggling Taxpayers

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