By Kevin Hagen, Contributing Writer

When you lose your job, you need to be aware of the tax consequences to avoid making costly mistakes and to take advantage of potential tax benefits.

Unemployment Compensation
According to the IRS, unemployment compensation is subject to federal income tax.

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.

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.

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.

Withdrawals from an IRA or 401(k)
You should avoid taking money out of your IRA or 401(k) plan.

Withdrawals are generally taxable and, if you are under age 59 ½, 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.

Potential Tax Benefits
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, you can claim a deduction for job hunting expenses. If you 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.

Filing a Return
Be sure your former employer has your correct address so 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, you should still file your return to avoid a penalty. You may be able to work out an installment agreement with the IRS.