February, 2010 Tax Newsletter

Tax Aspects of Employee Terminations

For those who have lost their jobs through termination or layoff probably the last thing on your mind is taxes.  However, the purpose of this month’s Tax Newsletter is to alert you to several tax aspects that, depending on your situation, may require you to make decisions that can affect your tax life this year and for years to come.  Here are just a few of the factors of which you should be aware:

Although severance pay is taxable and is subject to federal and state income tax withholding, some elements of a severance package may be specially treated. For example:

·         If you sell stock acquired by way of an Incentive Stock Option (ISO), part or all of your gain may be taxed at favorable long-term capital gain rates, depending on whether you meet a special dual holding period.

·         If you received or will receive what is commonly referred to as a golden parachute payment, you may be subject to an excise tax equal to 20% of the portion of the payment that's treated as an “excess parachute payment” under extremely complex rules.

·         The value of job placement assistance you receive from your former employer usually is tax free. However, the assistance is taxable if you had a choice between receiving cash and outplacement help.

You should also be aware that under the so-called COBRA rules, most employers that offer group health coverage must provide continuation coverage to most terminated employees and their families. The cost of any premium you pay for insurance that covers medical care is a medical expense and as a general rule results in a tax benefit only if your total medical expenses exceed 7-1/2% of your adjusted gross income.   (In Arizona, there is no limitation on deducting medical expenses).  However, if you have self-employment income following termination of employment, part or all of the cost of your medical insurance premiums may be deductible “above the line” (that is, deductible in arriving at adjusted gross income).

If your former employer pays for some of your medical coverage for a period of time following termination, you will not be taxed on the value of this benefit. And if you lost your job as a result of a foreign trade-related circumstance, you may qualify for a refundable credit for 65% of your qualifying health insurance costs.

Employees who terminate employment also need tax planning help to determine the best course of action for amounts they've accumulated in their former employer-sponsored retirement plans.  For most, a tax-free rollover to an IRA is the best move, if the terms of the plan allow a pre-retirement payout.  If you are under age 59½, and must make withdrawals from your company plan or IRA to supplement your current income, there may be an additional 10% penalty tax to pay unless you can qualify under one of several escape hatches.

Finally, the expenses, including travel expenses, of hunting for a new job in the same trade or business are generally deductible as miscellaneous itemized deductions.

If you are among those that are enduring changed professional and personal circumstances, I would welcome the opportunity to discuss these matters with you.