By Kevin Hagen, Contributing writer
When you lose your job, you've got enough on your mind without worrying about taxes.
Nevertheless, as you look for a new job, you need to be aware of the tax consequences to avoid making costly mistakes and to take advantage of potential tax benefits.
For example, be sure your former employer has your correct mailing address so that you receive your W-2, especially if you move.
If your income for the year drops below the filing limits, you should still file a return to claim a refund for the tax withheld while you were employed and to claim refundable credits.
If you owe taxes and can't pay them, be sure to still file your return to avoid a penalty. You may be able to work out an installment agreement with the IRS.
But that's just the beginning. Here are five more important things that could impact your taxes after losing your job ...
No. 5: Unemployment compensation
When you're out of work, unemployment benefits can be a godsend. They are also considered taxable income by the federal government.
According to the IRS, you must report all unemployment compensation you receive as income.
Generally, you enter unemployment compensation on line 19 of Form 1040, line 13 of Form 1040A or line 3 of Form 1040EZ.
When you apply for unemployment, you can have 10 percent withheld by completing Form W-4V. This way you can avoid owing tax when you file your return. You will receive Form 1099-G after the end of the year.
Otherwise, you can choose to make quarterly estimated tax payments.
Be careful, though. If you do not pay enough tax, either through withholding or estimated tax, or a combination of both, you may have to pay a penalty.
No. 4: Severance pay
Severance pay or accumulated vacation or sick pay also is taxable.
Tax will be withheld at the same rates as it was from your salary or wages while you were working. These amounts will be included on your W-2.
Remember that severance pay becomes taxable income for that year. If your severance is large relative to your salary, this could bump you into a higher tax bracket. In that case, negotiate to have it paid it out over time rather than in one lump sum.
While the government will take the usual bite out of your severance pay, there is some good news that may help that severance stretch a little further.
According to the IRS, certain expenses incurred while looking for a new job may be deductible. Examples of deductible expenses include employment and outplacement agency fees, resume preparation and travel expenses for job search and interviews for work in your current occupation.
No. 3: Income from self-employment
If you start a business or go to work on your own after losing your job, your earnings are taxable.
You should keep complete records of all your business income and expenses. You may need to make quarterly estimated tax payments, since income tax is not withheld.
If you work from home, you may be able to claim a tax deduction for business use of your home.
Be sure to check out the IRS' Publication 334, Tax Guide for Small Businesses, for more information.
The IRS also offers a number of small-business seminars throughout the nation. You can also order a small-business workshop DVD and other products through the IRS' Small Business and Self-Employed Tax Center website.
No. 2: 401(k), IRA withdrawals
You should avoid taking money out of your IRA or 401(k) plan and instead roll it over to another IRA or other retirement account.
Withdrawals are generally taxable and, if you are under age 59 and 1/2, you could be subject to an additional 10 percent penalty.
TurboTax online points out that if you have taken out a 401(k) loan and then lose your job, you must normally repay the loan within 60 days.
If not, the balance of the loan could be considered an early distribution subject to tax and the 10 percent penalty.
If the loan isn't repaid, you should receive a Form 1099-R, which would list the amount of the early withdrawal (Box 1) and how much of that amount is taxable income (Box 2a).
No. 1: Potential tax benefits
It takes a glass-half-full view of things, but not all of the tax impacts of losing your job are negative.
For instance, you may be able to claim the earned income credit if you have a lower level of income after losing your job.
If you pay someone to take care of your children or other dependents while you look for work, you can claim the tax credit for child and dependent care expenses, which can be up to 35 percent of your expenses.
If you itemize, and take courses to update or improve your skills, or decide to go back to school, there are tax credits for education expenses.
If you have to move in order to take another job or start your own business, you can deduct moving expenses without having to itemize. Make sure to keep all necessary receipts to claim these benefits.