If you have recently lost your job, you may be making ends meet through severance pay, other job-related compensation (such as vacation pay your employer has cashed out, your final paycheck, or other amounts you have earned, such as commissions), or unemployment insurance. If so, here's some bad news: Even though you are temporarily out of work, you still have to pay income tax on these amounts.
The basic rule is that you must pay income tax on severance pay. For example, if your employer pays one week of severance for every year of service, that money will be treated as income -- and you'll have to pay income tax on it -- in the year your receive it. Based on your anticipated earnings, you might want to ask your employer to defer some or all of your severance to the next tax year, if that would save you some money (and you can afford to get by without it for a while).
The same is true for other amounts paid to you by your employer, such as your final paycheck or unpaid commissions. A number of states require employers to pay employees for their unused, accrued vacation time: This money is taxable as well. Although it isn't generally legally required, some employers also cash out unused sick leave or annual leave. These amounts are also taxable.
Believe it or not, you also have to pay federal income tax on unemployment benefits. Some states also consider unemployment to be taxable income; others don't.
The small silver lining is that you may now have deductible expenses relating to your job search, which can lower your overall tax bill. Depending on your situation, these may include:
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