To manage tax and to make sure portion of your income drained as tax is low is a major issue for the young adults with their limited earning. Fortunately, the Internal Revenue Service offers a number of deductions, credits and other tax breaks that have particular appeal to those in their 20s.
We have mentioned some tips to help you reduce your tax liability:
1. Do not ignore Educational Tax Breaks
If a young adult has not finished his/her education, so education-related tax breaks can be valuable. The American Opportunity Credit pays 100 percent of the first $2,000 and 25 percent of the next $2,000 in expenses for the first four years of college, maxing out at $2,500 per student annually. If your undergraduate studies are behind you, the Lifetime Learning Credit will pay you up to 20 percent of eligible expenses of up to $10,000, which can contribute another $2,000 toward your educational aspirations. Income limits apply, but with no maximum number of years that you can use the Lifetime Learning Credit, it pays to take full advantage.
Remember that these breaks can be lowered if you have a 529 education savings plan.
2. Avail Deduction for Your Student Loan Interest
If your student loans qualify, you can deduct up to $2,500 in interest on your loans against your taxable income. Because the deduction is treated as an adjustment to income, you can claim this benefit even if you don’t itemize other deductions. The key is that you have to have taken out the loan to pay qualified higher-education expenses, and income limits apply. Besides you can claim deduction of scholarships received, and tuition fees also.
3. Opening a Roth IRA can accrue long term gains
When people think about saving for retirement, they usually gravitate toward traditional individual retirement accounts because those contributions create up-front tax deductions. But often, early in your career you are in the lowest tax bracket you’ll ever face, and so it makes more sense to look at a Roth IRA.
With a Roth, you won’t get an up-front tax deduction on your contribution. But you also won’t have to pay taxes when you withdraw money from your Roth in retirement. Given how much -your INVESTMENT can grow over that span of 40 or so years, the tax savings in the long run is well worth giving up the minimal deduction you’d get now.
4. Retirement Savings Contributions Credit as a Bonus
Another great reason to contribute to a Roth is that if you qualify, you can get the Retirement Savings Contribution Credit, also known as the Saver’s Credit. This essentially matches up to 50 percent of your retirement contribution in the form of a tax cut and is designed to offer an incentive to low-income taxpayers to start saving for retirement. With singles earning up to $30,000 and joint filers earning up to $60,000 being eligible for credits of between 10 percent and 50 percent on the first $2,000 to $4,000 saved, the Saver’s Credit is icing on the cake for smart planners.
5. Look At Educational Tax Credits
The American Opportunity Credit (an extension of the old Hope Credit) and the Lifetime Learning Credit are education credits you can subtract in full from your federal income tax, reducing your taxes dollar for dollar.
American Opportunity Credit- This credit reduces your taxes by up to $2,500 per student for the education expenses of college students pursuing a degree during their first four years of attendance, as long as they are enrolled at least half time and don’t have a felony drug conviction.
Costs that qualify for the credit include tuition, fees, books, supplies and necessary equipment. And if your taxes are less than $2500, you can receive a refund for up to $1,000 of the credit. If your income exceeds $80,000 ($160,000 on a joint return), the credit will be gradually reduced. Your income has to be under $90,000 ($180,000 on a joint return) to receive a credit.
Lifetime Learning Credit- You don’t need to be pursuing a degree to qualify for this credit, which can be claimed by anyone who takes a course at a higher education institution. It covers the cost of tuition and books and equipment you are required to buy from the school.
You can claim a credit against your taxes of up to $2,000 a year per tax return, but you won’t receive a refund if the credit is greater than your tax bill. The credit is gradually reduced if your income exceeds $53,000 ($107,000 on a joint return). At $63,000 ($127,000 on a joint return) the credit is phased out.
In the past, the Earned Income Tax Credit was designed for low-income families. But more recently, changes to the law made the EITC available to people with no children, and now, singles making up to $14,590 and joint filers with incomes up to $20,020 can get the credit.
With a maximum credit of $496, the EITC isn’t the largest tax break available. But one particular benefit of the credit is that it’s refundable, which means you can collect it even if you otherwise don’t have any tax liability.
Thus with the right tax planning and few proactive decisions you can cut on your tax bill and better invest your hard earned income. You should also start exploring high paying job opportunities before you complete your education.
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.