It is an exciting time to see your child or grandchild complete college and enter the workforce. For many recent graduates this will be the first time that they have had to file their own tax returns. How can you help them successfully navigate this unfamiliar territory? Below are eight tax related considerations to share with your grad as they start their new career and prepare to file their own tax returns.
Eight tax considerations for recent college graduates
1. Tax due dates
2. Employee vs. independent contractor
In their first job after college, most graduates will be hired as “employees” by their employer. As an employee, your employer will withhold federal and state income taxes, as well as Medicare and Social Security taxes from your salary. Your employer will remit these taxes to the IRS and state taxing authorities on your behalf. Note that for Medicare and Social Security taxes, your employer is responsible for paying one-half of the tax due and the other half will be withheld from your salary.
It is important to note that even though you are having federal and state taxes withheld from your pay, you could still owe income taxes when you file your tax return (or conversely, you could be due a refund). Make certain you correctly and accurately fill out Form W-4 (provided by your payroll department) which will inform your employer how much money to take out of each paycheck for taxes. If too little is taken out, you could owe taxes, or if too much is taken out, you will have to wait until you file your tax return to get the money back from the IRS/state. The IRS has a tool on its website that is designed to help you determine proper tax withholdings.
Independent contractor classification
If you are classified as an independent contractor, the company that you work for will not be withholding any of these taxes from your employment income. Instead, it will be your responsibility to pay these taxes to the IRS and the state. In order to do this, you will need make quarterly estimated tax payments to the IRS and the state. These payments are due April 15, June 15, September 15, and January 15. As an independent contractor, since you are considered both the employer and the employee, you are responsible for both halves of the Medicare and Social Security taxes. Remember to take this into account when you calculate your quarterly estimates.
3. Individual tax brackets
For 2023, single individuals with taxable income up to $44,725 are in the 10-12% tax rate bracket, those with taxable income from $44,726 to $95,375 fall into the 22% bracket for the amount of income over $44,725. The maximum Virginia income tax rate is 5.75%. IRS Tax brackets change periodically. You can refer to the IRS website for tax bracket updates.
4. Standard deduction vs. itemized deductions
Individual income taxpayers can deduct from their gross income in arriving at taxable income either the standard deduction or their itemized deductions. For 2023, the standard deduction for an individual taxpayer is $13,850. Allowable itemized deductions generally include state and local income taxes (maximum of $10,000 allowed), home mortgage interest and charitable contributions. More than likely, if you do not have a home mortgage, the standard deduction is probably going to generate the highest tax benefit.
5. Health insurance
One of the biggest expenses that you will incur as you enter the workforce is the cost of health insurance. Health insurance costs have increased greatly since the provisions of the Affordable Care Act became effective in 2013.
Today, most employers offer their employees a high deductible health insurance plan coupled with a Health Savings Account (HSA). The HSA allows you to make tax deductible contributions to an account that you can use to pay for out-of-pocket medical expenses such as co-pay amounts for routine medical visits. Many employers will pay all or a portion of your monthly health insurance premiums and may match a portion of your HSA contributions. HSA matches by your employer are not taxable to you. Since health insurance is so expensive, it is really important for you have a firm understanding as to what benefits your employer offers and how much of that cost will be paid by the employer.
Independent contractor health insurance considerations
If you are an independent contractor, you will be responsible for acquiring your own health insurance, which is often expensive when not offered through a large group plan. To the extent you pay for your own health insurance, you can take a deduction on your personal tax return for the cost of your monthly premiums.
6. Maximize your contributions to your employer’s 401(k) plan
Most employers offer a retirement savings plan known as a 401(k) plan. You may not be eligible to enroll in the plan when you first start your employment. However, it is a good move from a savings and income tax planning standpoint to enroll in the plan as soon as you are eligible.
Money that goes into a traditional 401(k) plan is pretax; you do not have to pay tax on the funds that you contribute to the plan. Additionally, the earnings on your contributions to the plan are not subject to income tax until you take the money out of the plan.
Most employers will match, to some degree, the amount of money that you contribute to the plan. As a result, you should understand your employer’s specific plan to make sure you take full advantage of any matching opportunities.
Many employers now offer a Roth option in their 401(k) plans. Unlike traditional plans, contributions to a Roth plan are not tax deductible. However, all withdrawals in retirement from a Roth plan will be tax free. In the early years of your employment, the tax deduction from contributions to a traditional 401(k) may not be that significant. As a result, the Roth option may be a better option for you.
7. Student loan costs
Many of you will end your college days owing funds under some type of student loan plan. On your individual income tax return, you may be able to deduct up to $2,500 per year in student loan interest costs. This deduction is in addition to the amount of the standard deduction that you can claim. To qualify for the deduction, no one else can claim you as a dependent, your filing status cannot be married-filing-separate, and the loan must be considered a qualified student loan. If the interest is paid by your parents, you can claim the deduction as long as you meet the three tests described above.
This deduction phases out as your adjusted gross income goes above $75,000.
8. Education credits
When you file your federal income tax returns, you may be able claim education credits for some to the college costs that you incurred in your last year of college or current college costs if you are still attending school as your work. These credits include the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Tax Credit (LLTC).
- The AOTC may be claimed for up to four tax years for any one student. The credit per student, per year is up to $2,500. This credit phases out when your adjusted gross income reaches $80,000. Up to $1,000 of this credit could be refundable if certain conditions are met.
- The LLTC is a nonrefundable tax credit equal to 20% of the first $10,000 of qualified tuition fees paid during the tax year. The maximum credit is $2,000. The same adjusted gross income phase out rules that apply for the AOTC also apply to this credit.
As a new participant in the workforce, your recent college graduate has many tax related issues to consider. We hope your young adult finds these tips helpful as they navigate the less exciting side of adulting—tax compliance. If you have any questions on this topic or want to discuss changes in your tax situation now that you have one less dependent to claim, please contact your Keiter Opportunity Advisor.
About the Author
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.