BusinessWeek.com
January 25, 2007
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Smart Tax Strategies for Younger Workers
Still new to the ways of the IRS? Here are a few smart tips to help you get through tax day as painlessly as possible
Taxes are a headache by almost anyone's estimation. Despite occasional talk about simplifying the code, Americans' yearly encounter with the Internal Revenue Service probably won't get less complicated any time soon. For example, President Bush included a proposal in his State of the Union address Jan. 23 that would change the tax treatment of health-insurance benefits (see BusinessWeek.com, 1/24/07, "Salesman in Chief").Heady stuff when you're setting up your own financial house. Every year, a new batch of young workers dives into this tangled maze of credits and deductions without the benefit of experience. According to IRS demographic data, nearly a quarter of all individual income tax returns processed in 2004 were filed by taxpayers under 30. Many members of this age group face their own unique tax situations, whether it's not having a mortgage to pay or not receiving benefits at work (see BusinessWeek.com, 2/16/06, "Life Without a 401(k)").
Unfortunately, even the enthusiasm of youth probably won't keep taxes from being a chore. To make that job easier, this week's Five for the Money shares five basic tax tips for young professionals still getting the hang of dealing with the taxman.
1. Get It Together.
First, make sure your financial house is in order. The longer it takes you to gather up your various tax-related documents, the more it will cost to prepare your return, whether in time or money. "There's one major rule when preparing to file your taxes," explains John Deyeso, principal of New York financial planning firm Financial Filosophy. "Be organized and detailed."
What papers do taxpayers need? The list starts with the W-2 or 1099 form from your employer, or at a minimum your individual pay stubs. Homeowners will require 1098 forms from their mortgage lenders. Also locate any mutual fund 1099 forms or bank-dividend statements. Student-loan payments and receipts for continuing education, charitable donations, or moving expenses may come in handy as well (more on those later).
2. Decide Your Plan of Action.
Novice taxpayers face the question of whether they should do their taxes themselves or seek professional help. Even some financial pros say many young professionals should start out doing their taxes themselves using popular tax software like Intuit's (INTU) TurboTax or H&R Block's (HRB) TaxCut. "There's no better education than seeing where the numbers end up on the return," says Sammy Grant, president of SG Financial Advisors in Sandy Springs, Ga. "It's fine to hire a professional one day, but I recommend trying it on your own first."
On the other hand, professional tax advisers can help young workers get their tax lives on the right track at an early age, other experts say. "Correctly addressing tax implications early in one's career can also help establish habits that reinforce a savings ethic over a working lifetime for retirement needs," says Barbara Steinmetz, founder of Steinmetz Financial Planning in Burlingame, Calif.
Taxpayers who settle on a plan early will likely find themselves in better shape on Apr. 16, this year's tax deadline in most states. "Don't wait until the last moment," says Donald Duncan, principal of D3 Financial Counselors, based in Downers Grove, Ill. Duncan likes TurboTax, but young workers should ultimately pick whichever option makes the most sense for their particular circumstances.
3. Jump-Start Your Golden Years.
Now that it's 2007, there's little that taxpayers old or young can do to ease their tax bite for the previous year. However, contributions to an IRA can help trim your tax bill right up until tax day. The IRA contribution limit this year is $4,000 (see BusinessWeek.com, 1/11/07, "Retirement Savings: Five Tips to Catch Up").
Young workers can deduct these contributions from their taxes if they have annual income below $50,000, or if they don't receive a retirement plan at work. It may seem early to start saving for retirement, but IRA contributions can both trim your tax bill today and put you on a path for a better tomorrow. "I always recommend that you contribute the most you can afford, up to the maximum," says Susan Serota, chair of the American Bar Assn.'s tax section.
Regular contributions to a 401(k) or other workplace retirement plan throughout the year can also help shelter your earnings from the tax collector. In 2007, workers under 50 may contribute up to $15,500 to their 401(k). (Employees 50 years and older are allowed extra "catch-up" contributions of up to $5,000.)
4. Take Some Credits.
Young people who don't have a mortgage probably won't be able to itemize their tax deductions, financial planners advise. Still, that doesn't mean well-prepared taxpayers can't find ways to shield a little more money from the tax man.
For starters, those student-loan bills might finally pay off. Taxpayers with student loans may deduct up to $2,500 in interest related to a student loan, depending on their annual income. Your lender should send a form 1098-E statement listing the amount of interest paid.
Going back to school can help you save, too. Taxpayers enrolled in graduate school may qualify for the Lifetime Learning tax credit, again depending on income. The credit applies to tuition and related costs, but not books or room and board, and is worth 20% of up to $10,000 in college expenses.
Don't forget to claim your one-time telephone excise tax refund. The IRS expects more than 160 million taxpayers to request this payment, which aims to refund long-distance phone taxes collected under a recently scrapped, century-old law. For the 2006 tax year, taxpayers can either take a standard refund between $30 and $60 (depending on other deductions) or dig up their old phone bills and use the exact amount instead.
Young people who do itemize their deductions could possibly enjoy some additional tax benefits. Moving expenses, home-office expenses, non-reimbursed business travel expenses, and some other costs may be eligible for deductions. A tax adviser or some good tax software should be able to help you figure out whether you qualify.
5. Don't Get Excited About a Big Refund.
Nobody likes to end up owing money on their taxes. Still, young workers shouldn't let the lure of a fat check from the IRS sway them from a savvy, sensible tax strategy. "The best situation is when you get no refund, because otherwise you're giving the government an interest-free loan," says Chad Smith, a 28-year-old financial planner with Raleigh (N.C.)-based Financial Symmetry.
Be aware of the amount you're withholding from your paychecks. If you end up getting a big loan this year, adjust your W-4 form with your employer with an eye to coming out even next year. Workers who are self-employed or who don't get taxes withheld from their paychecks should make estimated tax payments each quarter—or else face a penalty at the end of the year.
When it comes to paying Uncle Sam, some of the best advice crosses the generational divide: Be prepared, contribute to a retirement savings plan, and try to make the right payments throughout the year. It won't make paying taxes any more fun, but it could improve your financial health. And it could give you some welcome peace of mind when April 16 rolls around.
