4 Tax Tips for Recent Graduates
Once you graduate college, likely won't be a dependent on your parents’ tax returns anymore, as an eligible student. It's important to understand if you're entitled to a post-college tax refund, and to make sure you comply with your obligations to the IRS.
If you’ve graduated from college, congratulations on the accomplishment. This is a time your financial responsibilities will likely increase, including complying with your tax obligations to the IRS.
Chances are good you were claimed as a dependent on your parents’ taxes while you were a college student. If you’re now on your own, you likely won’t get this tax benefit anymore. If you’re responsible for filing your own taxes for the first time, you need to understand what forms you’ll need and when you have to pay. And, filling out these forms can be complicated, so you’ll need to know how to do that, too.
While suddenly having to cope with tax obligations isn’t fun, the good news is, it’s common for your employer to just withhold the money you need to pay from your paychecks – as long as you complete your pre-employment forms correctly.
In fact, you may pay more than you need to in withholdings and be entitled to a post-college tax refund when tax season comes around. If you work with a tax professional you may be able to find even more options to reduce your tax liability owed to the IRS, or you can find deductions and applicable options when you use TurboTax, TaxAct, or other similar programs as well.
To make sure you’re doing what’s required of you – and that you’re not paying more in taxes than you need to – check out these important tax tips for recent grads.
On this page:
- Do Your Parents Claim You as a Dependent?
- Relevant Tax Documents to Know About
- New Job Considerations
- Student Loans and Taxes
- Tax Breaks You Can Claim
Do Your Parents Claim You as a Dependent?
Again, the first thing to know about taxes after you’ve graduated is that you may lose your status as a dependent. When you’re a dependent, your parents claim you on their tax return. Your parents are eligible for certain tax credits and deductions because of your status as a dependent if you meet specific requirements.
Post-graduation, chances are good you won’t meet those requirements anymore. There are two tests you could meet to be classified as a dependent on your parents’ tax returns. The first is the “qualifying child test” and the second is the “qualifying relative” test.
To meet the qualifying child test:
- You must be younger than 19 or younger than 24 if you’re a full-time student at the end of the calendar year.
- You must be younger than your parent and younger than your parent’s spouse, if your parent and parent’s spouse file a joint return.
- You must be a son, daughter, stepchild, foster child, sibling, half-sibling, stepchild, or descendant of one of these people. Adopted kids count.
- You must live with your parent for at least half the year, or you must fall into an exception for students who live apart for educational purposes or for a separation caused by military deployment or vacation.
- You must not have provided more than half of your own financial support during the course of the year.
- You must not file your own joint return unless you’re doing so only to claim a refund.
If you no longer meet the qualifying child requirements – perhaps because of your age – you could still be considered a dependent if you meet the qualifying relative test. This test requires that:
- You not be classified as a qualifying child.
- Your parent provide more than half of your total financial support for the year.
- Your income must be under $4,150.
If you’ve moved back home and haven’t found a job yet, your parents may still be able to claim you under these qualifying relative rules even if you’re too old to be a qualifying child. But, hopefully, you’re now earning too much money with your post-grad salary so you’ll now be filing your own tax return instead of just being a dependent.
Relevant Tax Documents to Know About
Once you’re no longer a dependent and are earning enough to file your own tax return, there’s a lot you need to know.
First, it’s important to understand the IRS forms you’re likely to encounter. Some of those forms will come from your employer. Others you’ll need to obtain and fill out or will need to complete electronically using a tax filing program.
The key forms you’re likely to encounter include:
- A W2: A W2 form is the form your employer sends you annually that details the amount you earned over the course of the year and the amount of taxes withheld from your paycheck by your employer and sent to the IRS on your behalf. You’ll need this form to complete your tax return and provide details to the IRS on what you earned and how much you paid.
- A 1099 form: If you’re an independent contractor instead of an employee, or if you earn non-wage income from other sources, you’re going to receive a 1099 form. This form lets you and the IRS know how much income was earned from other sources besides an employer. You’re solely responsible for paying the taxes on 1099 income – no employer withholds taxes for you.
- A 1099-INT form: If you earn interest on any of your financial accounts, you’ll receive this form detailing the interest income. You need it because you’re required to pay taxes on all income, including income earned from interest.
- A 1098-E Form: This form is vital to help you become entitled to one of the tax deductions you’re most likely to receive after graduation: the deduction for interest paid on student loans. You’re eligible to deduct up to $2,500 in student loan interest as long as your household income isn’t too high. The 1098-E form lets you know how much interest you paid.
Depending upon your situation, you may also receive other forms. For example, if you’ve bought a home and taken out a mortgage, you may get a 1098 form specifying the deductible interest on your mortgage. It’s important to keep any forms that come from people or companies you do business with, as you’ll need them when it comes time to submit your tax returns to the IRS.
You’ll use the 1040 form to file taxes. In previous years, there were a number of versions of the 1040 form, including a 1040EZ. But for 2018, the form has been simplified so it’s postcard sized. Every American uses the same form. Whether you file tax returns online or print them out and submit them via mail, the 1040 form is the “tax return” you’ll need to send in to the IRS.
New Job Considerations
Getting hired for a new job means filling out a lot of tax forms as a post-grad. That’s because for most taxpayers, money is withheld from their paychecks and sent directly to the IRS since the U.S. operates on a pay-as-you-go system.
To let your employer know how much to withhold from your taxes, you need to fill out a W-4 form. This form is called the Employee’s Withholding Allowance Certificate. There are instructions on the form to specify how many allowances you claim. The more allowances you claim, the fewer taxes withheld from your paycheck. You can also tell your employer if you want additional money withheld and sent to the IRS.
It may be tempting to claim lots of allowances so your employer withholds very little money from your check, and you pocket a larger paycheck. The problem is, if you underpay your taxes by not having enough withheld, you’ll owe a lot of money at the end of the year – and you might have to pay penalties. On the other hand, if you don’t claim any allowances and have too much withheld, you’ll get a nice tax refund, but you will have given the IRS an interest-free loan of your money throughout the year. It’s best to be accurate in filling out your form, which you can use as a foundation for the following year’s filing.
Student Loans and Taxes
As a new grad, your taxes may be pretty simple because chances are good you don’t have a lot of investment income and you won’t be itemizing on your tax return. But, on the other hand, you may be able to claim one important deduction: the deduction for student loan interest.
A deduction reduces your taxable income so you don’t pay taxes on that amount. Eligible taxpayers are allowed to deduct the lesser of $2,500 or the actual interest paid on student loans during the course of the year. This would mean, for example, that if your taxable income would normally be $25,000 in your first year out of college and you claimed this deduction, you’d only be taxed on $22,500.
You’re eligible to claim this deduction if:
- You paid interest on a qualifying student loan in the current tax year. A qualifying student loan is a loan for you, your spouse, or a dependent that was used to pay certain higher education expenses within a reasonable time after you took out the loan.
- You are legally required to pay interest on the student loan.
- You are not filing your taxes as married filing separately.
- You aren’t claimed as a dependent on anyone else’s tax return and, if you’re married filing jointly, your spouse also isn’t claimed as a dependent.
- Your modified adjusted gross income is below a certain threshold. The deduction begins to phase out if your income is below $130,000 if married filing jointly or below $65,000 for all other taxpayers. Once your income is $160,000 if married filing jointly or $80,000 for other taxpayers, you can’t claim any deduction for student loan interest anymore. These income limits are all for 2018 and will change periodically.
You should claim all deductions and credits you’re eligible for, to reduce the taxes you pay, so be certain you claim this deduction if you qualify.
Tax Breaks You Can Claim
In addition to the student loan tax deduction, there may be other education tax credits and deductions you can claim:
- American Opportunity Tax Credit: If you or a spouse is still going to school and pursuing a degree, you could be eligible for up to a $2,500 credit for educational costs.
- Lifetime Learning Tax Credit: The Lifetime Learning Credit credit is worth up to $2,000 if you’re paying qualifying expenses for higher education for yourself, a spouse, or a dependent. Also available is something called the American Opportunity Credit. It’s a credit for qualified expenses for post-secondary education, but there are guidelines and limitations to utilizing this.
- Retirement tax deductions: If you’re contributing to a 401(k) or an IRA, you could claim a deduction for the amount contributed up to $18,500 for a 401(k) or $5,500 for an IRA in 2018 (These limits can change annually and are higher if you’re over 50).
Each specific tax credit and deduction will have its own requirements. And, there may be other deductions or credits you can claim specific to your situation, such as the Earned Income Tax Credit or a deduction for mortgage interest. Most online tax prep software helps you figure out the credits and deductions you’re eligible for by asking you some simple questions about your life.
While both a deduction and a credit reduce your taxable income, a credit is far more valuable because it provides a dollar-for-dollar reduction on the tax you owe. If you’d normally owe $5,000 in taxes and you get a $1,000 credit, you only owe $4,000 in taxes. But, a $1,000 deduction, on the other hand, just reduces the income you’re taxed on. So if you were in the 22% tax bracket, a $1,000 credit would save you just $220.
Taxes are a Part of Life – Know the Rules
Taxes are one of the least fun parts of being an adult – but it’s important to make sure you know the rules, file your forms properly during tax preparation and claim all the deductions and credits you can, including for qualified education expenses. And you may just be entitled to a post-college tax refund in your first working year, so be certain to file your taxes to get your money back if you’ve overpaid the IRS or reduce your tax bill.