Tax Breaks for Recent College Grads

FROM WSJ.COM-

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.”

5 Tax Strategies to Pay for College Without Going Broke

Saving for college is not for the faint of heart. The cost of an education has been spiraling upward and although there are some fine 529 plans to help, the numbers can be mind-boggling.

For men and women who own their own businesses, there are a few tips that can help them create a “tax scholarship” for their children.

Owning your own business gave him the chance, he said, to take advantage of IRS rules to help pay the tuition bills.

There are also various tax credits, including the Lifetime Learning Credit, which allows parents to deduct $2,000 of educational expenses per year for dependent children.

Any strategy to help ease the tuition burden must be weighed against the tax consequences to the prospective student and the parents.

1. Hire Your Children

Giving the kids the chance to work is a good way to shift income. This helps because they probably won’t earn enough to owe taxes. The money can be set aside in an IRA or other investment vehicle. For example, if a child does office work or painting or lawn mowing on rental properties for, say $2,500 per year, the savings can build up over several years before high school graduation. Cummings says it’s important to document the job and ensure that the work is legitimate.

2. Stock Transfer

Putting stock owned by parents in the name of a child can save tax payments. Beware, Cummings says, of the so-called kiddie tax, though, that mandates children can make at most $2,000 per year in unearned income using this strategy. Anything above that is subject to the tax rate of the parents.

3. Tuition Reimbursement

Offering employees tuition reimbursement for taking college courses can lower costs because of the tax benefits associated with such programs. The IRS puts a cap of $5,250 on such a program. It’s important that all employees receive the same benefits. In other words, the children of the business owner can’t receive a benefit not available to other employees.

4. Gift or Leaseback

By making a gift of a piece of property to a child and then leasing it back, the money saved in lower tax payments can be put toward paying for college, as can any lease payments. Beware of the kiddie tax mentioned in No. 2, which applies up to age 24 unless the child is no longer a dependent of the parents.

5. Divorce Planning

For couples no longer married, but able to work on college strategies together, there are ways to maximize tax benefits. Generally, such planning involves deciding which parent claims a deduction for the child as a dependent, leaving the other free to take advantage of tax saving rules while avoiding the kiddie tax.

Who Should Take Education Tax Breaks: Parents or Students?

When it comes to education tax breaks, it’s important to carefully consider your options, and plan out who is going to take what tax break. This is an important distinction because it’s an either/or situation in terms of who gets the tax break. If the parent claims the education tax deduction or credit, then the child (in this case, the dependent) can’t claim it. If the child claims it for himself or herself, then the parent can’t claim it. Parents have to communicate with their kids since the education tax breaks are only allowed to be claimed on either one of your tax returns and not both.

Is the Student a Dependent?

First of all, you need to determine if the student is a dependent. If a parent claims his or her student as a dependent, then that’s who gets to take the tax credit or education deduction. Whether it’s the American Opportunity Tax Credit, Lifetime Learning Credit, or the Tuition and Fees Deduction, only one person gets the tax advantage and it often comes down to whether the student is a dependent in the eyes of the IRS. If a student is a dependent on someone else’s tax return, the student doesn’t qualify for these tax breaks.
If a student isn’t claimed as a dependent, though, it’s possible for him or her to claim an education tax credit, or take the deduction.  One thing to keep in mind, each student cannot claim more than one tax break. So it’s one of the education credits or education deduction (not all of them).

Should the Student Take the Tax Credit or Deduction?

In some cases, it makes sense for the student to take the tax break. If the student is married, and no longer dependent on a parent for support, obviously that’s who should take the education tax break. Additionally, if the student makes enough money to owe taxes, it makes sense to reduce that tax bill as much as possible.
Most of the time, though, students don’t earn enough money to owe taxes. As a result, in many cases, it makes more sense for parents to claim their children as dependents and reap the benefits of the tax breaks. After all, parents have spent quite a lot to raise their children, and probably help pay for college. It’s only reasonable that they receive some sort of financial benefit in return – and a lower tax bill is one way to recoup a few of those costs.