LAST REVIEWED Sep 18 2019 13 MIN READ
By The Human Interest Team
Now is the perfect time to do some tax planning for the year. You work hard for your money, and you want to keep as much cash as possible. Smart tax planning can help! From my mid-20s, I started doing something that saved me thousands of dollars over the years: keeping current with tax laws. Although you’re required by law to pay federal, state and local income taxes, you’re not obligated to pay a penny more than your fair share. I’ll be explaining a variety of ways to legally minimize your tax obligations. First, bookmark IRS.gov. It’s probably the biggest money saving website there is! Whether you complete your taxes online, go to a tax preparation company or buy tax preparation software, it’s important to understand how your federal taxes are computed and the ways to both lower your taxable income and reduce your final tax payments. Young professionals may save thousands over a lifetime with smart tax planning early in their careers.
How can I reduce my taxable income in my 20s? Step one: A 401(k).
There is a legal way to significantly reduce your taxable income. Imagine if you earn $65,000 per year, but only had to pay tax on $47,000. Here’s how anyone can enjoy this tremendous tax savings. Contribute the maximum $18,500 per year to your workplace 410(k) account (and if you’re over age 50, the maximum 401(k) contribution amount increases to $24,500) and your taxable income is reduced by the amount of your 401(k) plan contribution. If your employer does not offer a 401(k), read this article for some tips to make a convincing case for it, both for yourself and for your co-workers’ sakes! For example, if your employer offers you the Human Interest 401(k) plan, you sign up online and you’re directed to a simple risk and income analysis quiz to help create the right investment portfolio for you. After this step, the Human Interest portal recommends certain low-fee diversified funds to invest in. Any money you invest here will be deducted from your taxable income. You’ll be planning ahead by saving for retirement and decreasing your tax payment in the short term, which is a win-win scenario.
Earned Income Tax Credit (EITC) for freelancers, those just getting started and low to moderate earners
The Earned Income Tax Credit amount is a tax benefit for low to moderate income individuals and is directly subtracted from your income tax owed. Even if the credit amount is greater than your tax liability, you’ll get a refund check. To qualify for the credit your income can’t surpass certain levels, which varies based on marital status and number of children. This benefit might be applicable if you’re just getting started, you’re a moderate income freelancer or started a new job in the fall and only earned a limited amount for the year. Maybe you’re going to school and working part-time as an Uber driver or are working for a moderate salary at a non-profit. The EITC could save you a great deal on your taxes.
Get paid to save with Saver’s Credit
Another benefit for low to moderate income earners is the Saver’s credit, formally known as the Retirement Savings Contributions Credit, which is a direct offset for taxes owed. Here’s how the Saver’s Credit works:
First, you contribute to your 401(k), IRA, or other retirement account.
If you meet the income requirements, in addition to the other benefits of the retirement plan contribution, the IRS refunds 50%, 20%, or 10% of your contribution up to a total of $2,000 or $4,000 if married filing jointly.
Your credit amount depends upon your adjusted gross income (AGI).
In 2015, single filers earning less than $30,50 were eligible for this credit and married filing jointly tax filers earning up to $61,000 could apply for the Saver’s Credit. Let’s consider an example case: Jenae works at Sephora, is married, and earned $35,000 in 2015. Jackson, Jenae’s husband, was unemployed in 2015 with no income. In 2015, Jenae contributed $1,000 to her IRA. After deducting her $1,000 IRA contribution from her AGI, her joint income is $34,000 and on top of the reduced taxable income, she may claim a 50% tax credit or $500 for her IRA contribution.
Take advantage of your student loan debt: Take the Student Loan Interest Deduction
If you attended college, it’s likely that you’ve accumulated student loan debt. You might be able to deduct a portion of your student loan interest payments from a qualified student loan. In 2015, you were eligible to deduct the lesser of these two amounts: $2,500 or actual interest payments. As your modified adjusted gross income (MAGI) increases, this deduction is reduced and ultimately phased out, which is why the best time to take advantage of it is when you’re just starting out in your career. If all of these conditions apply, you may claim the student loan interest deduction:
You paid interest on a qualified student loan
You are legally obligated to pay interest on a qualified student loan
Your filing status is not married filing separately
Your MAGI is less than the annually pre-determined amount
You or your spouse, if filing jointly, cannot be claimed as dependents on someone else’s return
Related article: Should I Contribute to My 401(k) or Pay off Debt?
Still studying and learning? You might qualify for the Lifetime Learning Credit
For the ambitious young professional, working on an undergraduate, graduate, part-time, or other degree, you may qualify for the Lifetime Learning Credit (LLC) as long as you’re enrolled in an eligible educational institution. Find out if you qualify. You must meet all three conditions to claim the LLC:
You, your dependent or a third party pay qualified education expenses for higher education
You, your dependent or a third party pay the education expenses for an eligible student enrolled at an eligible educational institution
The eligible student is yourself, your spouse or a dependent you listed on your tax return
In order to claim the full LLC, your MAGI must be $55,000 or less if you’re a single filer or $110,000 or less if married filing jointly. The maximum credit is $2,000 per return and varies based upon total educational expenses as well as income levels.
New job? Deduct moving expenses on your 1040
If you’re one of the thousands who switched jobs this year, you may be eligible to deduct reasonable moving expenses. If you meet these three requirements, you might enjoy a lower tax bill:
Your move happened with one year from the start of your first day at your new job
The distance test-your new workplace is at least 50 miles from your prior home and work location
The time test: your new job is full-time and you work at least 39 weeks during the subsequent year after the move
If you’re in the Armed Forces, and your move is due to a military order and change of station, you’re exempt from the distance and time tests. IRS Publication 521 spells out the details of this tax deduction.
Teachers: Use the Educator Expense Deduction
These important young professional educators get benefits from the IRS. On occasion, educators pay out-of-pocket for classroom tools and supplies. The IRS offers relief for these expenses. If you’re an eligible educator, you may deduct up to $250 and $500 for married educator spouses filing jointly. Eligible expenses include payments for books, supplies, computer related equipment and supplementary classroom materials. More detail is provided on the IRS page here. Eligible educators include kindergarten through grade 12:
Educators must work at least 900 hours a school year in an elementary or secondary school to qualify for this tax break.
Do you have a high deductible health insurance plan (HDHP)? Save on taxes with a Health Savings Account (HSA)
With the preponderance of high deductible health insurance plans (HDHP), an HSA offers another way to reduce taxes and secondarily to increase your retirement savings. The HSA is a tax advantaged type of account, for eligible employees, that you can use to pay for certain medical expenses. The benefits of a Health Savings Account are:
Even if you don’t itemize your deductions, you can claim a tax deduction for contributions into the account.
Employer contributions to your HSA might be excluded from your gross income.
The contributions remain in your account until you use them. (You can let them grow in the account for the future.)
There are typically several investment options within the account and earnings on the funds grow tax free.
If used for qualified medical expenses, distributions may be tax free.
The HSA isn’t tied to your employer and belongs to you if you change jobs or retire.
There are several requirements for the HSA:
You must be covered with a HDHP.
You can’t be covered under Medicare or be a dependent on someone else’s tax return.
Vigorous retirement savers who meet the HSA requirements can also contribute to the HSA as a tactic to increase their tax-advantaged retirement savings. These credits and deductions are a sample of the tax benefits for young professionals. Depending upon where you live and your personal situation, there may be other opportunities to slash your tax bill. If you do nothing else, make sure to contribute to your workplace 401(k). And then, with all this money you’ve saved on taxes, be sure to be thoughtful about how you use it — any money you save now will have a huge impact on your finances in the future since you’re starting so young. We have a separate article about how to prioritize across competing priorities here: Paying Off Debt vs. Saving: How to Prioritize and we also recommend this very thorough Reddit /r/personalfinance thread: ELI22: Personal finance tips for older young adults. We hope you found this helpful! If there are any other finance tips you want to see, let us know :). Make sure your employer offers a 401(k)>>> Image credit: Lalala666 – Wikipedia EN, Public Domain
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.