Please note that some content within this post has since been superseded by the Tax Cuts and Jobs Act which was signed into legislation on December 22, 2017.
Taxes are not just a grown-up thing…anymore. Anyone with earned or unearned income during the year must seriously evaluate whether they are legally obligated to pay and/or file taxes. This includes children who are beneficiaries of trust funds, people on social security, dog walkers, babysitters, along with the average wage worker and so on.
So while taxes affect nearly anyone and everyone of all age groups, why is it that tax breaks for the youth seem so limited and scarce? In this post, we’ll explore the Tax Hipster’s top 10 tax saving tips for the young professional taxpayer.
#1: Earned Income Tax Credit (EITC)
The Earned Income Tax Credit is a refundable tax credit that can be viewed as a wage subsidy for low to moderate income earners which applies to many college students working summer jobs or young professionals who are just starting out in their career.
If you are working this year and expect your income to be less than $53,930, you may be eligible to claim the EITC which offers refunds of up to $6,318 for those who file a return and have qualifying children. Individuals with no qualifying children are eligible for a smaller credit of up to $510.
#2 Retirement Savings Contributions Credit (Saver’s Credit)
Easily one of the most underrated credits available, the Saver’s Credit is a tax credit for eligible contributions made to a retirement plan such as a traditional or Roth IRA, 401(k), SIMPLE IRA, and other qualified plans. This is a true life saver as it makes it easier for you to save money instantly by getting a dollar for dollar tax break while allowing you to set aside funds into a savings plan for your retirement. Voluntary after-tax employee contributions to your qualified retirement and 403(b) plan also count as an eligible contribution to receive the Saver’s Credit which is great since many employer-sponsored retirement plans are matched by employers—meaning compound savings!
If your filing status is single and you expect to make less than $31,000 in the current year, you may be eligible for a credit of up to 50% of your contribution to a qualified retirement plan. The maximum income threshold for married filing jointly and head of household is $62,000 and $46,500 respectively.
#3 Student Loan Interest Deduction
If you are part of the 70% of undergraduate and graduate students who have taken out student loans, paying back your loans and residual interest may result in one of the better tax deductions—especially since the Student Loan Interest Deduction directly reduces your adjusted gross income. Although this is not a credit, reducing your adjusted gross income can be especially useful in claiming certain itemized deductions or qualifying for certain credits like the Earned Income Tax Credit or Saver’s Credit as previously mentioned.
You may be eligible to deduct up to $2,500 of interest paid on a qualified student loan subject to certain phaseout rules. In order to qualify for this deduction, you must pay interest on a qualified student loan during the calendar year that you were legally obligated to pay, your filing status is not married filing separately, you and your spouse (if filing jointly) cannot be claimed as a dependent on someone else’s return, and your modified adjusted gross income is less than $160,000 if you are filing married filing jointly or $80,000 for all other qualifying filing statuses.
#4 American Opportunity Tax Credit (AOTC)
Going to college not only provides a rewarding educational experience, but can yield massive tax savings. The American Opportunity Tax Credit is a refundable tax credit for qualified education expenses paid towards any of your first four years of higher education. It can be claimed by the student, or if claimed as a dependent on someone else’s tax return, may be claimed by that filer (usually the parent) if all of the requirements are met.
If you qualify for the AOTC, you may be entitled to get a maximum annual credit of $2,500 per eligible student. As a refundable tax credit, if the credit brings the amount of tax owed down to zero, you can receive 40% of the outstanding credit (up to $1,000) refunded to you.
#5 Lifetime Learning Credit (LLC)
For those who no don’t qualify for the American Opportunity Tax Credit, the Lifetime Learning Credit is available as its name suggests—throughout one’s lifetime. This credit is helpful as it allows students to pay for undergraduate as well as graduate and professional degree courses.
In order to qualify for the LLC, you, your dependent or a third party must pay for qualified education expenses for higher education pursued by an eligible student enrolled at a qualifying educational institution. Certain income limitations do apply. For those who qualify, the LLC is worth up to $2,000 per tax return.
#6 Premium Tax Credit
2014 marked the first tax year in which taxpayers were required report whether they had obtained minimum essential health coverage in accordance to the Affordable Health Care Act. Despite all of the fuss and complaints, it’s not a complete money drainer. For those who have obtained qualifying health care coverage from the Health Insurance Marketplace, there is a credit for you!
The Premium Tax Credit is a refundable tax credit designed to help individuals and families afford health insurance coverage as now required by law. This credit is unique in that it can be paid in advance so that taxpayers do not have to wait until tax season to receive a refund. In order to be eligible for this credit, you must buy health insurance through the Marketplace, cannot be eligible for coverage through an employer or government plan, meet the income threshold, generally may not file Married Filing Separately, and cannot be claimed as a dependent by another person.
#7 Moving Deductions
All those years you were away at college may finally pay off. If you moved during the calendar year due to a change in your job or business location, or because you started a new job or business, you may be able to deduct your moving expenses. The best part about the Moving Deduction is that it directly reduces adjusted gross income, similar to the Student Loan Interest Deduction, meaning that it can benefit you in the long-run by allowing you to claim more itemized deductions in certain cases as well as increase your chances of qualifying for various tax credits which are reliant on adjusted gross income.
There are three main factors that determine whether your moving expenses are deductible. Generally, you can deduct your moving expenses if your move closely relates to the start of work, you meet the distance test (usually at least 50 miles from your old home), and time test.
#8 Itemized Deductions – It’s Doable!
Itemized deductions are just for homeowners and investment bankers. While a large majority of taxpayers opt to take the standard deduction, you could potentially save a lot more money in taxes if you accumulate expenses worthy of itemization.
There are no income limits or requirements to itemize deductions. Keep in mind that you are entitled to the greater of the standard deduction or itemized deduction when calculating your taxable income. For young professionals who do not own a home, do not fret as there are still a bunch of expenses that count as itemized deductions which can really add up. This includes medical expenses, charitable contributions, certain job-hunting costs, home office expense, unreimbursed employee business expenses (such as meals and entertainment, travel, mileage, and more), tax preparation fees, investment fees, and so on. With some good tax planning, young professionals can very well itemize their deductions and benefit from some smart tax savings.
#9 Personal Exemption
This one might be a no-brainer, but for recent college graduates and people in their early twenties, it might be instinctive to have your parents claim you as a dependent on their tax return. They’ve been claiming you for as long as you can remember, so why wouldn’t they continue to claim you either as a qualifying child or qualifying relative? Nonetheless, once you begin racking up a considerable amount of income and are legally required to file your taxes, it may be in your best interest to claim yourself even if you do not provide for over half of your own support.
There are numerous perks to claiming yourself on your own tax return. You get a higher standard deduction, the personal exemption of $4,050 which directly reduces taxable income, and the door opens to a whole bunch of tax credits you can potentially claim. While this definitely seems like the good life, it may still be beneficial to file with your parents or whoever supported you during the year in the event that you did not make enough money to get the most out of all these tax savings. However, that is a tax planning discussion for another day. What’s important is realizing that this is a viable option available to you when filing your taxes.
#10 Don’t get greedy
The best tax advice anyone can give you is to file honestly and file with integrity. You may be thinking, well isn’t that obvious? But surprisingly, where most people get stumped is during an IRS tax audit. Filing your taxes is the easy part, but substantiating your income and deductions may be a bit more difficult–especially if you are purposely making false claims in hopes of receiving a larger refund.
If you plan on itemizing deductions or claim moving expenses, then be sure to keep your receipts so that when it comes time for an audit, you are prepared and are not left paying hundreds of dollars in interests and penalties. Especially for taxpayers who are in their twenties, the last thing you need are back-taxes, bad credit, and a levy or lien being placed on your assets. It just isn’t worth it.
I hope you found these tax savings tips to be interesting and insightful. As a young professional, myself, I want to be aware of every tax saving available to me–no matter how little. To learn more about these tax savings deductions and credits and whether you are eligible to claim them, see the Footnotes & Annotations below or consult a tax professional.
Footnotes & Annotations
- EITC: https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/eitc-income-limits-maximum-credit-amounts-next-year
- Saver’s Credit: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-savings-contributions-savers-credit
- Student Loans: https://studentloans.net/student-loan-debt-statistics/ & https://www.irs.gov/publications/p970/ch04.html
- American Opportunity Credit: https://www.irs.gov/individuals/aotc
- Lifetime Learning Credit: https://www.irs.gov/individuals/llc
- Premium Tax Credit: https://www.irs.gov/affordable-care-act/individuals-and-families/the-premium-tax-credit
- Moving Deduction: https://www.irs.gov/taxtopics/tc455.html
- Itemized Deduction: https://www.irs.gov/taxtopics/tc500.html
- Personal Exemption: https://www.irs.gov/uac/newsroom/in-2017-some-tax-benefits-increase-slightly-due-to-inflation-adjustments-others-are-unchanged