Top three tax tips for recent graduates
Some milestones are celebrated with cake and pats on the back, and others come with having to take on more responsibility. When new college graduates leave school, many likely don’t realize now is the time for them to start paying more attention to their tax situation.
They might have filed their own tax returns before, but for many this is a turning point. Understanding some basics about income taxes can help new graduates be less anxious about the tax filing process and help them better manage their money.
More money, more tax liability
The good news is the average starting salary of 2017 college graduates is $49,785, which is 3 percent more than the 2016 average. The “bad” news? Generally, the more money they make, the more they will pay in taxes.
Graduates fortunate enough to earn this year’s average starting salary have surpassed the filing requirement threshold by a wide margin. That means they must file a tax return. If they fall short of the average starting salary, whether or not they must file will depend on if they are claimed as a dependent by their parents, their age and exactly how much money they make. With all of these factors playing a role, recent graduates who may appear to be in a similar financial situation can have very different filing requirements.
Paperwork just begins on the first day of work
Employees fill out a W-4 when starting a job to determine – within limits – how much in taxes will be withheld from their checks. Their employer will use their marital status and number of allowances they claim on the W-4 to calculate how much federal income tax to withhold from their paycheck: the more allowances claimed, the less tax withheld. A W-4 calculator can help taxpayers estimate their taxes owed or tax refund based on how they complete their W-4.
If they will owe no taxes, some employees can fill out the W-4 so no tax is withheld. This will prevent them from needing to file a return to claim a refund. Taxpayers who will owe taxes should be careful about claiming too many allowances or claim they are exempt from tax, because they could face a large bill in April, including penalties for underpayment throughout the year.
Employees can also fill out another W-4 at any time. Changing how much tax is withheld from their paychecks can help them get the outcome they want in April. For example, common life changes like getting a raise, having a baby, buying a house or getting married can impact how much taxes they will owe. By changing their withholding as life happens, they will have more time to make course correction more meaningful and less painful.
After the end of the year, employers give employees their W-2 as a record of how much money they received in wages and how much they paid in taxes. Taxpayers will need this information to prepare their tax returns. The employer also sends the W-2 to the IRS and the Social Security Administration. By law, the Form W-2 must be available to employees in late-January either in a copy mailed to their home and/or online.
Planning for retirement can start now
Thinking about what they want their lives to look like when their career ends can help new graduates get an early start on saving for their retirement.
People entering the workforce need to know about the advantages of saving money for retirement in a tax-deferred account. Saving this money for retirement can reduce how much income is currently taxed and how much income is taxed much later, when they retire and take distributions from the account. That means paying less in taxes now.
There’s still plenty of time for new graduates and employees to get comfortable with their post-college personal and work lives before they file their 2017 tax returns next year. But in the meantime, they can learn more about other decisions to make when starting their first job, like enrolling in a 401(k), using an FSA and HSA or choosing health care coverage.
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Here are a few things to know if it's your first time filing taxes so the process can be as simple as possible with the best outcome for you.