Most college graduates have had federal income tax taken out of a pay check. If you are like most students you got these taxes returned to you when you filed your federal income tax return. Those days are done once you start your career. Your federal income taxes will be major part of your budget.
Outlined below are some guidelines for reducing the pain of your federal income taxes.
- Be careful when you fill out the W–4. The W–4 is the document you sign when you first go to work. It determines the taxes that will be withheld from your paycheck. If you are single, claiming one exemption will be fine.If you are married and you and your spouse have a combined income above $70,000, you will probably need to adjust your withholding. At approximately $70,000 the tax rate changes. The combined income you make that is above $70,000 will be taxed at a higher rate than the income below $70,000. If both of you claim a single exemption, then you won’t have enough tax withheld from your paycheck. At the end of the year, you will owe more taxes to the IRS. In addition, you will have to pay interest on the additional money you owe the IRS.
- Deductions are what reduce your taxable income. For most recent graduates, you won’t have enough deductions to itemize them. You will probably be taking a standard deduction at first. This deduction varies by the number of persons in the household. The standard deduction changes each year, but it’s approximately $6,000 for you and an additional $6,000 if you are married. For example, if you and your spouse make $72,000. Your taxable income would be reduced by $12,000 to give a taxable amount equal to $60,000.
- Credits reduce your taxes. For example, if your tax obligations are $5,700 and you have a tax credit of $300, then you will own taxes of $5,700 – $300 = $5,400. The most likely credit that you might take advantage of include
- Lifetime Learning Credit – You can reduce your taxes by up to $2,000 for qualified education expenses.
- Child Care Credit – You can reduce your taxes by taking a credit for part of the expenses you paid for child care.
- Exemptions – These reduce your taxable income. You claim an exemption for yourself, your spouse, and any children. The exemption for each person for 2012 was $3,800. Thus if you are married and had an income of $72,000, your taxable income would be reduced by $72,000 – 2x 3,800 = $64,400.
- Itemized deductions – You will eventually be able to itemize deductions. You can do this as soon as your deductions exceed the standard deduction. The types of things you can deduct from your taxable income include:
- Medical and dental expense – These include money you spent directly from your medical and dental care. It does not include money paid by a health insurance provider. You can only deduct this amount if it exceeds 7.5% of your taxable income.
- Taxes you paid – This includes state and local income taxes, real estate taxes, personal property taxes, and other taxes. It does not include most types of sales tax.
- Interest you paid – The big item here is the mortgage interest on your home. Generally you won’t have enough deductions to itemize unless you have purchased a home.
- Gifts to charity – These include gifts to any charitable organization
- Casualty and theft loss – This includes such things as damage from storms, fires, vehicular accidents, etc. It only includes what was not reimbursed by your insurance.
- Job expense – These include job travel, union dues, referred educational expenses, etc. These have to be at least 2% of your taxable income.
A couple of final notes on your tax strategy.
- Learn how to do your own federal income taxes. This will help you understand how to be smart about the taxes you pay.
- Try to buy a home as soon as possible. This is probably the only way you can reduce your taxes significantly.
- Keep a file for all tax information. This includes anything you need to complete your return. It should also include all of your past returns.
- When you get married, make sure to adjust your W–4 tax withholding.