It's never too early to start planning for your financial future. Here are some key tax tips for people who are nearing graduation or have just finished an undergraduate degree.
- Student loan interest is deductible
- Refinancing for a better rate
- Student loan forgiveness and your taxes
- 401(k) plans through your employer
- Individual Retirement Accounts (IRAs)
- Make the correct withholding selection on your W-4
- Inquire about your company's HSA or FSA plans
- File a tax return for each state in which you live and work
- Deduct self-employed business expenses
The decisions you make during and after college are important, especially when it comes to your tax return. Opportunities like the Lifetime Learning Credit and student loan interest deductions might only be available to you for a short time, so you may want to take advantage of them while you can. Doing so will help ensure your financial future is bright.
Before you throw your cap in the air, let's talk taxes.
If the cost of repaying your student loans has your head spinning, here are some tax tips to keep in your back pocket.
American Opportunity tax credit
During the first four years of college, you can take advantage of the American Opportunity Tax Credit (AOTC), formerly known as the Hope Credit. It allows you to claim a credit of up to $2,500 per student for qualified education expenses like tuition, books, equipment, and school fees. A tax credit is different from a deduction; a credit reduces the amount of taxes you owe dollar for dollar. The AOTC is considered the most generous education credit because up to $1,000 of it is refundable. This means that if you don't owe any taxes, you can still claim the credit and receive a refund.
Lifetime Learning Credit
If you don't qualify for the AOTC, consider the Lifetime Learning Credit. It applies to expenses that you incur when taking nearly any higher education course, and when taking non-degree-seeking courses to improve job skills. Unlike the AOTC, it can be claimed any time, year after year, with no limit on the number of years you can claim the credit. The credit is 20% of up to $10,000 of qualified education expenses, with a maximum annual credit of $2,000 per tax return. Keep in mind, this credit isn't refundable. For this reason, most students claim the AOTC in their first four years of college, after which they claim the Lifetime Learning Credit.
Student loan costs
For most student loans, interest starts to accrue the minute the loan is taken out. So, while you may have just graduated and have a 6-month grace period to start making payments, you'll want to educate yourself on the terms of your student loans now.
Student loan interest is deductible
You could qualify for a deduction of up to $2,500 on the student loan interest you pay every year. This is in addition to your standard deduction, which is $13,850 for 2023 tax year for single filers. This means if you make $45,000 at your first job, you could deduct up to $16,350 on your 2023 taxes and pay taxes on only $28,650 of your earnings.
But, the amount of student loan interest you can deduct is reduced and eventually eliminated if your modified adjusted gross income (MAGI) is above $75,000 for the year.
Refinancing for a better rate
Refinancing your student loans could help you lock in a lower interest rate, which will reduce the amount you pay over the life of your loans. And fortunately, refinancing generally won't negatively affect your finances. If your interest rates drop, you'll have less student loan interest to deduct, but the amount of money you save over time will be well worth the trade-off.
Student loan forgiveness and your taxes
The American Rescue Plan made federal student loan forgiveness nontaxable for tax years 2021 through December 31, 2025, but beginning in 2026, taxpayers may be required to pay taxes on loans that are forgiven or canceled. Right now, federal loans are only forgiven for borrowers in specific circumstances.
While it may seem a bit early for new graduates to start thinking about retirement, it's never too early to start saving for it. Investing sooner rather than later allows you to take advantage of the power of compounding interest and grow your money over time.
Here are two simple investment options to consider.
401(k) plans through your employer
Most employers will sponsor 401(k) retirement plans or similar qualified retirement plans as a perk for their employees. Even small contributions you make to your plan will add up over time. At a minimum, be sure to contribute enough to capture the match.
For example, your employer might agree to match 100% of your contributions at up to 3% of your salary. If you earn $45,000 per year and elect to contribute 3% of your salary ($1,350), your employer will match that contribution and contribute $1,350 of their own money into your retirement account. Plus, most 401(k) contributions are made with pretax dollars, which reduces your taxable income.
Individual Retirement Accounts (IRAs)
If your employer doesn't offer a retirement plan, if you are self-employed or freelancing, or if you simply want other investment options, you may consider opening an IRA. An IRA is like a 401(k) in that it offers tax-deferred savings options earmarked for retirement, but you may have access to a wider selection of investments through a broker if you opt for an IRA.
Based on your income level, a Roth IRA could also be a good option. Contributions to Roth IRAs are made with after-tax dollars, but they allow for tax-free growth and tax-free withdrawals in retirement. Single filers with income under $153,000 (in 2023) can contribute to a Roth IRA.
Considerations for first-time workers
Many people who pursue higher education wait until after college to start their first full-time job. If you're in this situation, there are a number of tax considerations to keep in mind.
Make the correct withholding selection on your W-4
When you start a new job, your employer will ask you to fill out Form W-4. This form helps determine the amount of income tax your employers will withhold from your paycheck. If your employer withholds too much throughout the year, you'll get a refund, and if they withhold too little, you'll owe taxes. Your goal should be to not owe anything come tax time. If you file your tax return and your withholdings didn't cover your tax liability (or if you have earnings from self-employment), you may need to pay estimated taxes each quarter to make up the difference.
Inquire about your company's HSA or FSA plans
A health savings account (HSA) or flexible spending account (FSA) allows you to save taxes on healthcare costs, including prescriptions, copays for doctor visits, or even new glasses. Each employer has its own set of guidelines, so be sure to ask about the differences between these plans if your job offers one or both.
File a tax return for each state in which you live and work
If you live in one state but commute to work in another, you are responsible for filing a tax return in both states. Income earned in your "work state" will need to be claimed on both returns, but rest assured, you won't be double-taxed; on your "home state" return, you can claim a credit for taxes paid to other states. Depending on where you live, you may not need to file in your work state because some states have reciprocity rules where commuters don't need to file dual returns.
Deduct self-employed business expenses
If you work for yourself, either full- or part-time, you are able to deduct business expenses such as equipment, office supplies, business insurance, etc. But if you work for an employer, you are unable to deduct business-related expenses even if those expenses are unreimbursed by your employer. This means that moving costs, professional continuing education, office supplies, and similar expenses you pay for out-of-pocket aren't deductible (except for teachers, who can deduct $250 of qualified expenses). This rule applies for tax years 2018 to 2025.
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