This post is part of a three post series which walks a recent graduate through filling out their W-4 and filing their taxes. After these three posts, recent grads should be squared away with Uncle Sam come April.

Post 1: How To Fill Out A W-4 For A Recent Graduate
Post 2: How To Figure Out Taxable Income for a Recent Graduate
Post 3: How to File Your Taxes for a Recent Graduate

The W-4 is History, Now What?

By now you have already been working for a while. And by now you have hopefully had a chance to receive a few paychecks and make a few decisions that will impact your future. Have you stormed into the HR Manager’s office demanding to know why your starting salary is 30% less than they promised? No? Good… that means you still have a job. If you have closely examined your checks you probably started to notice all of the deductions for things such as:

• Federal Tax (Varies)
• State Tax (usually 0% to 12%)
• City Tax (for those of us who are that unfortunate… mine is around 4%)
• Medicare (1.45%)
• Social Security (6.2% on the first $97,500)
• 401k Contributions (You hopefully elected to contribute!)
• Miscellaneous other things (Perhaps a health care reserve account?)

Everyone files.

The important thing to note is that no one misses the party when it’s an open bar. And the same goes for the government and your paycheck.

You could make the decision to not file taxes, of course. And you could also wind up like Al Capone or Wesley Snipes. Point being you may get away for a while, but the government always gets what they are due. In time.

Tax Advantages

One important thing to note about taxes that a lot of recent graduates do not understand is that there are a lot of tax advantages people can take part in. The point is to take your income (the money you make) and deduct as much from it to create a taxable income (the amount of income they will actually tax). That’s why you checked with your parents to make sure they weren’t claiming you anymore. And that may be why Mom and Dad fought over the lost receipt for the work laptop and filing cabinets.

Why is your taxable income different than your actual income?

To put it quite simply… the government has set up incentives for people to do things that they think is beneficial for the country. That’s why you see tax breaks on buying a home, having children, giving money to charity, or re-education.

Stock Investments

If you made any stock investments you are only taxed once you sell them for the most part. If you sell them within a year of purchase you are taxed at your normal tax rate for your earnings. However, as mentioned before, the government rewards good behavior. So if you owned the stock for more than a year, hence helping the market stability, you will be taxed at a lower capital gains tax rate.

Reduce Your Taxable Income

So, let’s start with one of the first ways you may be able to decrease your total income: Have a dependent. A dependent is, as the name implies, someone who depends on you for housing, food, etc. Do you have a child or a sibling that you are the legal guardian for? Make sure to read up on all of the special qualifications but if you do that gets you a deduction of $3,500 from your total income.

You may be thinking about the fact that you surely feed yourself and house yourself. And you are right, but you are not called a
deduction. You are an exemption. The $3,500 still applies.

Next you get to take deductions. Most people coming out of college can take the standard deduction of $5,450 which applies to everyone. However, if you consult with a tax professional they may be able to itemize that for you and get you more. Once you start donating to charities, paying mortgage interest, racking up medical bills, paying real estate tax, paying hefty state taxes, and doing other things itemizing will become more attractive.

As I mentioned, hopefully you have been contributing money into your 401k. This money is contributed tax free. This means that your company takes it from your paycheck and puts it right into your fund before the government even sees it. If you were to contribute 10% of a total income of $30,000 your total income would suddenly appear to be $27,000 to the government.

 

For recent graduates in particular there are two extra deductions which come into play. These are not itemized, they are on top of the standard deduction! These are:

• Student Loans – You can deduct the student loan interest you pay. This benefit lowers once you make $50,000 and disappears at $65,000. (IRS Publication 970 [PDF] page 28  for details)
• Moving Expenses – If you had to move to accept your job offer, you may qualify for some tax deductions. You had to move more than 50 miles. And you can only claim the expenses your company doesn’t pay for. You also have to be employed for 39 of the next 52 weeks. You can count hotels, but not food. Check out the form. (Tax Form 3903 [PDF])

How to Tabulate Your Income

To come up with the number that will represent your taxable income you need to subtract all of the numbers from above from your total income number. Your total income + stock gains if they were sold within a year minus your retirement contributions, personal exemption, standard deduction, student loans, and moving expenses. If you run through these numbers, hopefully you are starting to understand why it is so important to keep track of these numbers and think wisely about decisions that affect your tax situation.

If the taxes were sold after a year, as I mentioned they are taxed at a lower rate and should be computed separately.

So How Much Do You Owe in Taxes?

One common myth people have is that their whole income is taxed at the same rate. That’s where the asinine statement “I don’t want to make more money cause I’ll pay more in taxes!” comes from. The USA uses tax brackets. Look at the pictures below to figure out the brackets in which your money will be taxed.

(thanks for the pics allfinancialmatters.com)

As an example, if you are single and make $30,000 a year after all of the deductions your first $8,025 will be taxed at 10% and the remaining $21,975 will be taxed at 15%.

How to File

Come back next week and I will make a post on how to actually file the taxes. Post with any questions, comments, or suggestions!

*These circumstances are different for EVERYBODY. Please consult with a tax specialist before making any decisions.*

Recommended

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