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Updated on Monday, February 27, 2017
When life changes, so do your taxes, and graduating from college brings several life changes that can affect your tax return. You may go from being claimed as a dependent by your parents to filing on your own for the first time. You may move out of state, collect a paycheck for the first time, and start paying off student loans. All of these events present opportunities to save — and costly pitfalls to avoid. To help you keep more of what you earn in this next phase of life, check out these tax tips for recent college graduates.
Figure out if your parents can still claim you as a dependent
If you just graduated, you may still be eligible to be claimed as a dependent on your parents’ tax return. Dependency rules are complex, but essentially, for your parents to claim you as a dependent:
- you must be under age 24 at the end of the year,
- you must be a full-time student (enrolled for the number of credit hours the school considers full time) for at least five months of the year,
- you must have lived with your parents for more than half the year (you are deemed to live with your parents while you are temporarily living away from home for education), and
- your parent must have provided more than half of your financial support for the year.
If you meet all of these tests, your parents can still claim you as a dependent and take advantage of the dependency exemptions and education credits.
Even if your parents claim you as a dependent, you may still be required to file your own return if you had more than $2,600 of unearned income (interest, dividends, and capital gains) or more than $7,850 of earned income (wages or self-employment income).
Get reimbursed for moving expenses if you moved in order to take a new job
If you moved for a new job after graduation, you might be able to deduct any unreimbursed moving expenses, as long as the new job is at least 50 miles away from your old home. Those expenses include costs to pack and ship your belongings and lodging expenses along the way, but not meals. You can also take a deduction for 17 cents per mile driven for 2017 (down from 19 cents per mile in 2016).
If you moved out of state, you might have to file two state returns if you had taxable income in both states. Many students have a part-time job while in school and take a full-time job in another state after graduation. Rules vary drastically by state. In some states, you will have to claim 100% of your income on your resident state return, then receive a credit for any taxes paid to another state. In this case, you may be better off working with a professional who can help guide you through filing in both states.
Make sure you’re withholding the right amount from your paycheck
When you start your new job, the human resources department will ask you to complete a Form W-4 to indicate how much of your paycheck you’d like your employer to take out for taxes. Working through the questions on the form is simple enough, but it doesn’t take into account how much of the year you’ll be working.
Most new graduates end up having too much federal tax withheld in their first year, effectively giving the government an interest-free loan, says Bradley Greenberg, a CPA and partner at Kessler Orlean Silver & Co. in Deerfield, Ill.
That’s because graduates rarely start new jobs right at the start of a new year. You may graduate in May and start working in June, or graduate in December but not find a job until February. Yet you are taxed as if you have been earning that pay for the entire year.
“The withholding tables are designed with the assumption that one makes the same amount of money for each pay period of the year, regardless of how many pay periods were worked,” Greenberg says. “For example, a June graduate starting a job on July 1 for $50,000 will have the same taxes withheld per pay period as a colleague with the same salary, marital status, and number of exemptions, but who worked the entire year.”
Greenberg recommends two courses of action for new graduates:
- Set up your withholding in your first year of employment so less tax is withheld. Then make sure you adjust it on the following January 1, so you don’t have too little tax withheld in your first full year of employment, or
- View this as a savings plan and file your taxes as early as possible next year to get your refund from the IRS.
Take advantage of student tax credits
If your parents can no longer claim you as a dependent, you may be eligible to claim valuable tax credits for any tuition you paid during the year. There are two tax credits for higher education costs: the Lifetime Learning Credit and the American Opportunity Credit.
For 2016, there is also the tuition and fees deduction (Congress failed to renew this deduction, which expired on December 31, 2016, so it is not available for 2017). The rules and income limits for each credit and the deduction vary, but the IRS offers an interactive tool on their website to help you determine which tax break applies to you.
If you used student loans to pay for your education, you can take a deduction for up to $2,500 of interest paid on a qualified student loan. If your parents made loan payments on your behalf, you are in luck. Typically, you can only deduct interest if you actually paid the debt, but when parents pay back student loans, the IRS treats it as if the money was given to the child, who then repaid the debt.
Don’t ignore your 401(k) or health savings account at work
New college graduates may be financially strapped and hesitant to divert part of their paycheck into a retirement plan or health savings account, but opting out means missing out on substantial tax-saving and wealth-building opportunities.
If your employer offers a matching 401(k) contribution, as soon as you’re eligible you should contribute at least enough to get the employer match. Otherwise, you’re missing out on free money. If you select a traditional 401(k), you can save on next year’s taxes. That’s because any contributions you make will be tax free, and they will reduce the amount of your income subject to federal income tax as well as Social Security and Medicare (FICA) taxes.
For better or for worse, many employers now offer high-deductible health insurance plans. These plans often come with health savings accounts (HSAs). Any money you set aside in an HSA can be used for any qualifying medical expense, from co-pays to prescriptions. The best part is that money you put into your HSA is not taxed, so you can potentially save a lot by using your HSA for medical expenses rather than paying out of pocket.
HSA funds stay in the account until you use them and are portable, meaning you can take it with you even if you leave your job. If you have big medical bills down the road, the funds can come in handy. If not, think of them as another tax-advantaged way to save for retirement.
Bring in a professional if you think you need help
If this is your first time filing on your own, you may be wondering whether you should do it yourself or pay someone to prepare your return for you. If you have a simple return with just a Form W-2 and perhaps some interest income, you could save money by buying some tax software and doing it yourself. MagnifyMoney’s guide to the best tax software is a great place to start.
But if you have dependents, investments, or a small business, you may be better off going to a reputable accountant.
Doing your taxes is never fun, but for recent college graduates, they may not be as big a headache as you might have heard. Keep in mind that tax laws often change, and everyone’s situation is a little different. But taking the time to know which tax breaks apply to you can make your post-college life significantly easier.