Money Saving Tax Tips for Young Professionals
As the weather warms and spring nears it marks the inevitable start to tax season for young professionals across the country. Taxes for many are far from exhilarating and few people, outside of Certified Public Accountants (CPA), fully grasp all of the moving pieces to their taxes. Nonetheless, tax planning is a critical component of overall financial planning and most importantly it can help save you money if done correctly. In today’s blog we’ll provide a crash course on a few important tax tips and considerations for young professionals.
Student Loan Interest Deduction
For many young professionals fresh out of college or just finishing up their graduate degree, student loans are almost a given. In fact, nearly seven out of 10 graduates now leave school with student loans meaning many young professionals are in a position to take advantage of the student loan interest deduction.
The IRS allows you to deduct up to $2,500 a year of the interest you paid on your student loans “above the line” which means it does not matter if you are itemizing your deductions or using the standard deduction. However, that deduction amount is phased out at certain levels of income. Singles earning more than $85,000 (in modified adjusted gross income-MAGI) or couples earning more than $160,000 (in MAGI) unfortunately no longer have access to the deduction.
Health Savings Account (HSA) Deduction
Another above the line deduction, not impacted by whether or not you itemized your deductions, is the deduction given to Health Savings Account (HSA) contributions. The HSA is a powerful savings vehicle for health expenses largely because any dollar put into the account drops your taxable income dollar-for-dollar and there is no phase out, while any money withdrawn for qualified medical expenses can be done so tax-free.
In 2015, the maximum contribution amount to an HSA is $3,350 for individuals and $6,650 for families. One last important thing to note, you need a High-Deductible Health Plan (HDHP) in order to contribute to an HSA in the first place. If you have excess money at year-end and haven’t yet maxed out your HSA (assuming you’re eligible), this is a great place to stash that money in order to receive a tax deduction come April.
IRAs and 401ks
Another powerful way to lower your taxable income is to make a contribution to a retirement savings vehicle such as an Individual Retirement Account (IRA; $5,500 max contribution in 2015) or a 401k (max contribution $18,000). Both of these vehicles allow you to stash away pre-tax dollars in preparation for retirement, while in the current tax year allowing you to lower your taxable income. For each dollar contributed to either of these accounts, you lower your taxable income dollar-for-dollar.
An important distinction between these two vehicles is that an IRA phases out your deduction, while a 401(k) does not. For example, for singles covered by an employer retirement plan their tax deduction starts to phase out once income (MAGI) reaches $61,000 and is fully phased out at $71,000. The same applies for couples when income reaches $98,000 with the deduction fully phased out at $118,000. Lastly, keep in mind that IRA contributions can be made up until the tax deadline (April 18 this year), so if you have excess money but forgot to do it in 2015 you can still contribute even though the New Year has already come and gone.
Note: Roth IRA and Roth 401K contributions do not receive a tax deduction, however, any money withdrawn in retirement is then tax-free. For example, if you have income of $100,000 and you contribute $4,000 to a Roth IRA/401(k) you’re still taxed on $100,000.
Tuition and Fees Deduction
Young professionals can deduct up to $4,000 in qualified education expenses for themselves, a spouse, or a dependent (can’t claim something a dependent paid for) for the first four years of college. The deduction, however, is limited by an income phase out for any single filer making in excess of $65,000 and any couples in excess of $120,000 in 2015.
It’s also important to remember that the IRS does not allow you to double dip, meaning you cannot take a deduction for an expense you are utilizing an education credit (see below) or some other form of tax-favored money to cover (i.e. 529 plan).
American Opportunity & Lifetime Learning Credits
The American Opportunity Credit allows young professionals who are taking college courses, on at least a half-time basis, a $2,500 credit to help offset the cost of qualified educational expenses (i.e. tuition and other required fees, books). It’s also important to note that the credit is tiered and applies to 100% of the first $2,000 in qualified expenses and then to 25% of the next $2,000. In short, you need at least $4,000 in qualified expenses to receive the full $2,500 credit which reduces taxes owed dollar-for-dollar.
Young professionals also have access to the Lifetime Learning Credit which is a $2,000 tax credit (20% of the first $10,000 in qualified expenses) if you are making payments to a post-secondary educational institution, however, you do not need to be working towards a degree. The nice thing about this credit is that you are not limited by how many years you can use it (assuming you qualify), whereas the American Opportunity Credit can only be used four times.
Oftentimes this credit will be used for graduate school, assuming an individual used up his or her American Opportunity Credit while getting an undergraduate degree.
Note: These credits cannot be combined in the same year on the same student, so it’s important to coordinate and is oftentimes advantageous to utilize the American Opportunity Credit due to the higher credit amount.
Lastly, it is important to keep in mind that the tax law is full of exceptions to the rule and that for any individual’s situation there are likely many moving parts that could impact the deductions and credits discussed above. This is precisely why it is so important to speak with a CPA on any matters that may be unclear.
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