You’ve thought long and hard about leaving your current employer and are now ready to make the move. However, before you clear your desk and head for the door, here are a few tax tips to consider.
Your final paycheck may include — in accordance with your employer’s policies — payment for accrued but unused holiday/vacation and sick leave, unpaid commissions and bonuses, and severance or termination pay. These items will be included in your gross income for the year and subject to both income and FICA (Social Security and Medicare) taxes. Depending on your situation, you may want to amend your W-4 before the payment is made to ensure you’ll have the proper amount of income taxes withheld for the year.
Generally, private employers with 20 or more employees and state and local governments are required to allow terminating employees to elect a continuation of their health insurance coverage for themselves, their spouses, and dependent children (“COBRA” coverage). Typically, you should expect COBRA premiums to be higher because your employer will no longer be paying a portion. You may want to seek out more affordable options through your spouse’s group health plan or the Health Insurance Marketplace.
Health insurance premiums are qualified medical expenses and, therefore, eligible to be taken as an itemized deduction. Generally, medical expenses are deductible only in the amount that exceeds 10% of your adjusted gross income (AGI). (If you or your spouse is 65 or older, the deduction threshold is 7.5% of AGI.)
If you participate in your employer’s qualified retirement plan, such as a 401(k) plan, you should receive a notice regarding your distribution options. Generally, you may either take an immediate taxable distribution or make a direct or indirect rollover to another tax-favored retirement account.
From a tax standpoint, the direct rollover is usually the preferred option when you are switching jobs because it allows you to avoid current taxes and continue saving for retirement. Typically less desirable is the indirect rollover, which would involve you receiving the money first and then depositing it in another retirement plan or individual retirement account (IRA) within 60 days.
An indirect rollover presents a potential tax trap since your employer is required to withhold 20% of the balance and forward it to the IRS to be applied to your federal income-tax liability for the year. You’ll have to make up that 20% shortfall with money from an outside source to complete a rollover of the full amount within 60 days. If you don’t, the 20% will be deemed a taxable distribution. Depending on your age, you could incur a 10% early distribution penalty in addition to regular income taxes on the shortfall.
If you’ve taken out any loans from your employer’s retirement plan, you may be required to pay them immediately or within a specified period following termination. Failure to timely repay the loan can result in your former employer reporting it as a deemed distribution from your retirement plan. Again, you would owe income taxes and a potential additional 10% penalty on the amount.
Job Search Costs
Expenses associated with looking for a new job in the same trade or business are potentially tax deductible as a miscellaneous itemized deduction. Allowable expenses include the cost of résumés, postage, job counseling, employment agency fees, and telephone charges. However, miscellaneous expenses are deductible only in the amount that exceeds 2% of your AGI.
Janney Montgomery Scott LLC, its affiliates, and its employees are not in the business of providing tax, regulatory, accounting, or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any taxpayer for the purpose of avoiding tax penalties. Any such taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.