You are young and just starting out in your career, with your whole life ahead of you. Taxes may not be on the bottom of your list of concerns, but we will bet that it is pretty close.
However, we suggest you raise tax savings a little bit higher on your list. After all, money that you save in taxes can be used for things that are higher on your list of concerns. Here are a few possible ways for you to send less to Uncle Sam and more to your wallet.
- Consider Itemizing – It is typical for younger taxpayers to stick with the standard deduction rather than trying to itemize – you may think itemizing is only for older, established and wealthier workers. That is not necessarily so. In fact, many deductions phase out at higher income levels.
Look over the potential itemized deductions in IRS Form Schedule A and see if they add up to more than your standard deduction amount. Categories include medical and dental expenses, state and local taxes, charitable gifts, and certain job related expenses. Some computer programs make this comparison easy for you.
- Above the Line Deductions – These deductions lower your Adjusted Gross Income (AGI) – the amount on which you pay taxes. These are called “above the line” deductions because they are physically located above the line on the 1040 form where your Adjusted Gross Income is located. You can take these deductions whether you itemize or not.
Common above the line deductions are educator expenses (allowing you to deduct up to a certain amount of classroom expenses that you pay for), moving expenses associated with a new job, certain business expenses by performing artists, and educational deductions for interest on student loans.
- Tax Credits – Tax credits are taken directly off the taxes you owe, not the income that is taxed – so if you qualify for any of these, you should certainly take them. Common ones are the Earned Income Tax Credit for low-income households, which may earn you a refund even if you do not owe any taxes.
If you are still in school, you may qualify for the American Opportunity Tax Credit or the Lifetime Learning Credit. Information on these and other tax credits may be found at the IRS website.
- Check Your Withholding – Every year, you have to select the number of deductions you take on your W-2 form; this tells your employer how much money to withhold from your taxes. If you are getting a refund every year, you are withholding too much. Why not make interest on your money instead of letting the government do it?
Do not forget to take into account life events such as raises, marriage, or new children that will affect the amount you need to withhold. Change your W-2 at the earliest opportunity.
- Consider a Roth 401(k) – Roth 401(k)s are funded with after tax dollars, as compared to the traditional tax-deferred 401(k) that is funded with pre-tax dollars. That seems like a tax disadvantage, so why would you consider this? Because you are looking at the long-term picture, and saving yourself from taxes in retirement.
By preferring to take your tax hit early, you are assuming you will be in a higher bracket in the early retirement years – a reasonable assumption if you are just starting out on your first job.
Take some time to look for tax savings. You may well save yourself enough money to buy that sports car you always wanted – or perhaps a few cups of coffee. Either way, it is a win.