When I was in my 20s, I was single, without kids, renting, had graduated from college, working at my first job and no interest whatsoever in taxes. My feeling was, Why should I waste time thinking about taxes? As a single, renter with no kids, I would get absolutely no deductions or credits -- and in addition to that, I had nothing to itemize. That meant I should have just filled a 1040EZ and been done with it, right? Right?
Most of us who are starting our financial journey think this. It is not always true. The assumption that paying attention to taxes at this stage provides little benefit, can result in us losing out on a lot!
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That is why I decided to write this post, focusing on people in their 20s -- to get their attention, and to tell them there are reasons to take a second look at their taxes (though taxpayers of any age can equally take advantage of these deductions/credits).
A lot of tax software programs do guide you through these deductions. That, however, won't be of any help if you decide it isn't worth the time to go through the more time-intensive versions of the tax software and opt instead for the free EZ version. Others choose to go to one of the tax shops that crop up during tax season without realizing most of them are more interested in selling you a loan rather than doing your taxes correctly.
Which tax deductions or credits can you claim?
1. Moving for a new job:This is one of the most common expenses for new graduates who are starting their career. You don't need to itemize to deduct your moving expenses. According to the IRS, you can deduct your moving expenses if you meet all three of the following requirements:
- Your move is closely related to the start of work.
- You meet the distance test.
- You meet the time test.
If you move more than 50 miles for a new job in your field, you will most likely pass this test and qualify for a full deduction. This is an awesome deduction because it is an "above-the-line deduction," which means it will directly reduce your adjusted gross income.
2. Tax-efficient investing within your 401(k)/IRA:You might have already heard the advice to take advantage of your 401(k) and/or IRA -- Roth or traditional depending on your income. But why not take it a step further and do an audit to make sure you are investing in a tax-efficient waywithinyour 401(k) or IRA?
As a good rule of thumb, high-yield investments or investments that produce high dividends should be in an IRA/401(k) whereas low-yield investments, tax-exempt bonds and international investments (if you pay foreign taxes, to take advantage of the foreign taxes paid deduction) is better placed in a taxable account. Of course, if you can contribute only to one -- taxable or tax-advantaged account -- max out the tax-advantaged account first.
3. Use Roth IRA to save for your first home:When I started my first job, I decided there are a lot of things to think about before retirement. Retirement was a far-away thought; I had to save for my first home, a wedding, travel, etc. If I could go back and give some advice to my 20-year-old self, I would tell her to save first in a Roth IRA. I would tell her that renting is not bad, she is not ready to buy a house if she has not saved for retirement AND saved for a down payment. If for some reason, she has to buy a house and doesn't have enough for a down payment, she can always take the principal without penalty to buy her first home. So fill up that Roth IRA pot first before other goals. Compound interest is indeed the strongest force for anyone's finances.
4. Side hustles (declaring income and deducting expenses):I didn't concentrate on anything other than my job in my 20s, but with the newest disruptive technologies like Uber and AirBnB, a lot of the 20-somethings are making money from more than their jobs. It is a very welcoming trend and also very relevant for taxes. I have heard a couple of arguments that if it is paid in cash, it need not be reported in your taxes.Wrong!
Someone also told me that if they get less than $600 from any one source, they don't have to declare it.Wrong again!!!Uncle Sam wants his money; so every source of income, whether from a traditional job or a side hustle, has to be reported. Even if you earned $10, it has to be reported. Whether you get a 1099 or not, it has to be reported.
On the plus side, you can also deduct almost all the expenses you incurred to make that money. So record every single expense and income. If it comes from a hobby, you have to declare the income and can deduct the expenses up to the amount you made with that hobby. If it comes from a business, you can deduct everything, even if it exceeds the income. (However, if you keep declaring losses year after year, the IRS might not consider that as a business, so talk to an accountant to get more clarification in this area.)
5. Interest paid for your loans(even if they are paid by someone else):Do you have a student loan that your parents made a payment on? You might think that since they paid the loan, you can't deduct it. You still could. The IRS considers that as a situation where they paid you the money and you paid your debtor. So, as long as they don't claim you as a dependent, you can claim that payment on your taxes.
6. HSA by employer:If you are eligible for a Health Savings Account, consider taking full advantage of that. It can serve you as an excellent tax saver, a lot more than just paying for your health bills. (For more info: http://www.fivecentnickel.com/2010/02/22/using-your-hsa-as-a-retirement-investment-vehicle/)
7. Early withdrawal penalties:When I started saving for my goals, I was overzealous and opened a CD for everything, as the interest rates were higher. Unfortunately, I also had to break a CD well before it matured. At the time, I didn't know that the early withdrawal penalty I incurred was tax deductible if I reported the income, which I did. If you have any kind of early withdrawal penalty and you reported the income, it might be fully deductible. (IRA withdrawal penalties don't count, however.)
8. Educator expenses:If you are a teacher, the money you spend on your class supplies (which teacher doesn't spend their own money?) is deductible up to a certain limit.
9. Lifetime learning:Many college graduates think that all the education deductions only apply to expenses incurred toward getting a degree. But the government encourages lifelong learning; so as long as you are continuing your education in the same field and it will help your career, you can deduct those expenses. You can use this interactivetax assistant toolfrom the IRS to figure out if your expenses are deductible and under what category they fall.
10. Consider itemized deductions as well:Finally, most people in their 20s with no mortgage assume they have nothing to itemize. It is probably true (the standard deduction is more generous than people give it credit for), but it doesn't cost you anything other than may be 15 minutes of your time to check if itemized deductions might be better for you, especially if you had:
- any charitable expenses
- live in a state with a very high tax rate
- spend a lot out of your pocket for your job, or
- even if you spent a lot in the last year looking for a job.
As I mentioned, these are some of the deductions that everyone uses automatically but misses the eyes of people in their 20s. If we are eligible for a deduction, there is no reason not to take advantage of it to the fullest extent.
This article originally appeared at Get Rich Slowly.
The article 10 Tax Breaks for 20-Somethings originally appeared on Fool.com.
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