Entering “the real world” comes with a long list of responsibilities. One of which is accurately reporting and paying income taxes on time. In this guide, we’ll discuss the essentials of what college students and recent graduates need to know in order to efficiently handle taxes and take advantage of tax deductions and tax credits. The good news is as a college student or recent graduate, you might qualify to file your taxes for free.
Know Your Tax Bracket
How much you earn will determine how much you pay in taxes each year. A tax bracket specifies the percentage of taxable income that is paid in taxes. In 2020, for instance, single individuals who earned between $9,876 and $40,125 fell into the 12% tax bracket. Those earning between $40,126 and $85,525 fell into the 22% tax bracket.
As you can see, there’s a considerable disparity between these brackets, which will impact your total tax liability. So you’ll want to know exactly where you fall when entering the workforce. The Tax Foundation publishes tables of the updated tax brackets along with a downloadable PDF for quick reference.
Know Whether You’re an Employee or Independent Contractor
The majority of the workforce is classified as an employee — roughly nine in 10 workers, according to recent data. However, it’s increasingly common for college students and recent graduates to work as independent contractors. Many take on freelance jobs during the initial stages of their career and may not work for an employer in the conventional sense.
Tax reporting is handled differently depending on your classification, so it’s important to have a firm understanding of how each arrangement works. “For the employee, the company withholds income tax, Social Security, and Medicare from wages paid,” explains the U.S. Department of Health & Human Services. “For the independent contractor, the company does not withhold taxes.”
If you’re classified as an employee, your employer will automatically withhold your money and send it to the IRS, and you’re all set. However, if you’re classified as an independent contractor, you’re responsible for reporting taxes yourself and sending in either quarterly estimated tax payments or an annual tax payment.
For a detailed overview on the differences between an employee and independent contractor, check out this guide from Berkeley Law.
Know How Much to Withhold if You’re an Employee
If you’re classified as an employee, you’ll need to fill out a W-4 form before beginning your job. The way you fill out a W-4 will determine how much your employer withholds from your paycheck.
There are multiple options, so you want to choose the right one based on your situation. Failing to withhold enough tax can result in you owing a significant amount of money once it’s tax time in April and potential penalties. On the other hand, if you withhold too much, you’ll likely have a limited budget each month, which can be difficult for college students and recent graduates who are just starting out.
Be sure to carefully read through the W-4 to decide how much to withhold. You may also want to use the Tax Withholding Estimator, a free tool provided by the IRS.
Know the Tax Filing Deadline
The IRS has strict deadlines about when taxes must be reported each year. Failing to do so on time can result in some ugly consequences. According to Bill Smith, managing director of CBIZ MHM’s National Tax Office, the failure-to-file penalty costs 5% of your unpaid taxes for each month your tax return is late and goes up to as much as 25%. This penalty kicks in the day after the tax deadline ends.
That’s why you always need to know the tax-filing deadline and make sure you’re on time — ideally being a little early to give yourself some wiggle room. The deadline for filing a 2020 Individual Federal Income Tax return is April 15, 2021.
Understand Student Loan Interest Deductions
Approximately 70% of students in America take out some type of student loan to fund their education. If you fall into this category, you may be able to deduct up to $2,500 from your taxable income as long as you meet eligibility requirements, including the following:
No one is claiming you as a dependent
You’re not married and filing separately
You currently are or were enrolled at least half time
The amount of the student loan interest deduction is based on the amount you paid in interest on federal and private student loans during the previous calendar year. This deduction is an above-the-line exclusion from income, meaning that you can claim it even if you claim the standard deduction.
Also, note that there are earnings limits. In 2020, you must have earned less than $70,000 if you’re a single filer or less than $140,000 if you’re married and filing jointly.
Familiarize Yourself With Relevant Tax Forms
Finally, it’s important to have a basic understanding of the types of documents you’ll need for reporting taxes. For example, if you work for an employer, you’ll receive a W-2. If you’re an independent contractor, you’ll receive a 1099 from each company.
The 1098-E is a Student Loan Interest Statement — a form that shows how much interest you paid on your student loan during the year. There’s also the 1098-T Tuition Statement. “Schools must send IRS Form 1098-T to any student who paid ‘qualified educational expenses’ in the preceding year,” says TurboTax. “Qualified expenses include tuition, any fees that are required for enrollment, and course materials required for a student to be enrolled.”
These two forms will be necessary for student loan interest deductions, so be on the lookout for them in the mail.