Recent college graduates often go to extreme lengths to save a little money: Eating cereal for dinner. Wearing clothes from the hamper. Even couch-surfing at a friend’s place for weeks.
Yet many young people overlook money-saving features in the tax code that offer substantial savings. “Young people spend too much time obsessing over cutting little things,” says Sophia Bera, founder of Gen Y Planning, an online financial-planning firm in Minneapolis.
There are 1.6 million college graduates hoping to enter the workforce this year alone, according to the National Center for Education Statistics. Here are some notable tax breaks they should consider.
Student-loan interest deduction. The average 2014 college graduate owes over $37,000 in student loans, according to the NCES. As graduates start receiving paychecks and paying off their debt, they can reduce their taxable income by as much as $2,500 for interest paid on both federal and private student loans, according to the Internal Revenue Service.
Most borrowers who are single filers and who have adjusted gross income of less than $60,000 are eligible for the full deduction. Those with AGI between $60,000 and $75,000 are eligible for a reduced one.
For example, someone with about $55,000 in AGI who has annual interest payments on college loans of $2,500 or more can shave $625 a year off his or her tax bill.
Lifetime Learning Credit. This tax credit is worth up to $2,000 for those who are paying qualified expenses for postsecondary education, or paying them for an eligible student. You need to have been in school at least part of that tax year to claim it.
The credit works as a “nonrefundable” dollar-for-dollar reduction of one’s tax bill, according to the IRS. If the amount of tax owed is less than $2,000, for example, the credit will reduce the sum down to zero but won’t refund the difference. The amount of the credit is phased out when the filer’s AGI is between $53,000 and $63,000.
Students who graduated in May this year, or are still in college, also could be eligible for the American Opportunity Tax Credit—a $2,500 nonrefundable tax credit that is available only for the first four years of postsecondary education—says Jim Holtzman, chief financial officer of Legend Financial Advisors in Pittsburgh.
Moving-expenses tax deduction. Many recent graduates looking to relocate could benefit from this break, though the details can be tricky—and those taking it must meet stringent conditions imposed by the IRS.
Reasonable moving expenses covered by the deduction include packing and traveling costs, but not meals or costs related to car maintenance or depreciation.
Such expenses are eligible to be deducted if incurred within the period six months before or after the first day the filer reported at a new job, according to the IRS. The employee also must work full time for at least 39 weeks during the first 12 months after arriving in the general area of the new work location.
What if the move occurs when there are fewer than 39 weeks before the tax year is over? You still can take the deduction for that year if you expect to meet the 39-week requirement after the move.
In addition, the new workplace must be more than 50 miles farther from the employee’s old home than the old job was. If this is his or her first job, it must be more than 50 miles away from the old home.
Tax-smart saving strategies. The first place many young workers should start saving is in their employer-sponsored 401(k) retirement-savings plan. Contributions to such plans are pretax, meaning that taxes aren’t paid until the funds are withdrawn from the account. Many companies also offer to match your contributions up to a certain amount.
Next, consider individual retirement accounts. In a traditional IRA, contributions are made before taxes are due, and earnings are untaxed. Taxes are due upon withdrawal. In a Roth IRA, contributions are made after taxes, but earnings and withdrawals are untaxed.
On top of these accounts, low- and moderate-income workers—categories many recent grads fall into—also can get a tax credit on their savings. Voluntary contributions of up to $2,000 into qualified retirement plans, including 401(k)s and IRAs, are eligible.
Single filers earning less than $18,000 can get a tax credit for 50% of their qualified savings, up to $2,000. Those earning between $18,001 and $19,500 are eligible for a credit rate of 20%, and those who earn between $19,501 and $30,000 are eligible for a 10% credit rate, according to the IRS.
Says Gen Y Planning’s Ms. Bera: “This is one of my favorite credits because it is rewarding you for something that you should already be doing anyway—saving for retirement.”
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