Tax Saving Tips for the
Accidental Consultant

by Kathy M. Kristof | Mar 5, 2009 | Comments

Key Stats

• Jobs lost: 5.1 million since the recession began in December 2007.
• Deductible expenses: Employees can claim job-search costs like automobile mileage on their federal income tax return, within limits.
• Varying rules: You can write off more stuff using Schedule C, which is for entrepreneurs.
• IRS resources: Publication 529 spells out job-search write-offs for employees, and Publication 334 has rules for the self-employed.

The standard chin-up counsel you give friends who’ve been laid off is to start thinking of themselves as entrepreneurs, not as jettisoned employees. That turns out to be pretty good tax advice, too.

The reason: Job-related expenses for laid-off employees are severely limited by tax thresholds. If you reimagine yourself as a consultant, you can write off more expenses — including health insurance premiums — and you don’t need to worry about thresholds.

Deducting Job Expenses: Employees

As an out-of-work employee, you can deduct the cost of looking for a new job including resume preparation, automobile mileage to interviews, and career coaching as long as you are looking for work in the same profession that you left.

But there’s a big catch: These expenses can be deducted only as miscellaneous itemized deductions that exceed 2 percent of your adjusted gross income (2 percent of joint adjusted gross income if you’re married). That can be a tough threshold to clear. Moreover, the cost of your health insurance premiums under COBRA, likely to be four or five times what you paid as an employee, aren’t deductible unless they exceed 7.5 percent of your adjusted gross income.

To see how this might work in real life, look at imaginary couple John and Mary Smith. Mary earned $30,000 in 2008; John expected a total income of $125,000 but lost his job in March, before bonuses, so his 2008 wages were just $25,000. He collected $6,000 in unemployment benefits, bringing the Smiths earnings to $61,000. (For simplicity’s sake, we’ll assume that $61,000 is also the Smiths’ adjusted gross income.)

In 2008, John spent $500 making resumes and business cards and drove 500 miles going to job interviews and conferences, for which the IRS set a rate of 50.5 cents a mile from January 1 through June 30, 2008, and 58.5 cents a mile from July 1 through December 31. To search for a new job online, he bought a $1,100 computer with high-speed Internet access.

But here’s where John’s self-image makes a difference. Altogether, seeking work cost $2,500. As an out-of-work employee, John could write off only job-seeking expenses exceeding 2 percent of the couple’s $61,000 in adjusted gross income — those over $1,220. So, even assuming the IRS would accept the computer and Internet connection as deductible expenses which might be a stretch — the Smiths’ maximum deduction is $1,280.

As for health write-offs, assume that Mary had no health coverage through work, John paid $4,800 for COBRA health premiums for the last part of ’08, and the couple itemizes deductions. The health premiums get added with the Smiths’ $500 in other unreimbursed medical expenses. However, the total is deductible only to the extent that it exceeds 7.5 percent of their joint income, which results in a deduction of just $725.

All told, John Smith, ex-employee, spent over $7,800 looking for work and replacing his health insurance in 2008. Yet, of that total, all he could write off was $2,005.

Deducting Job Expenses: Entrepreneurs

If you’re self-employed, everything changes. Your health premiums are 100 percent deductible. And the ability to write off job-related expenses isn’t subject to deduction thresholds. The downside: You must pay self-employment taxes on your net business income and file a Schedule C, a form for declaring a profit or loss from a business. But, in the first year of being self-employed, your profits may be negligible, making the tax hit tiny.

Here’s how the write-offs would work for the Smiths: John could claim 100 percent of his health insurance premiums and all his job-seeking expenses. The computer and Internet access for John’s business? Unquestionably deductible. Total job-related write-offs: $7,300, or more than three times the amount as an employee.

Assuming John didn’t have much business income in 2008, posting a business loss would be considered an audit trigger. But if he kept good records showing that he was seriously seeking consulting work and aiming to turn a profit, he would have a strong case if challenged by the IRS. Once his newly minted business earns money in 2009, his burden of proof lightens. If he is still losing money after three years, however, he could have a tax problem. The IRS presumes that unless you’ve made money in three out of five years, your business is no more than a hobby.

But if you’ve just found yourself unemployed, ahem, turned into a consultant, five years is a long way off. In the meantime, the IRS is willing to share some of the burden of your getting back on your feet. Take full advantage.

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