10 tax breaks for 20-somethings

When I was in my 20s, I was single, without kids, renting, had graduated from college, working at my first job and no interest whatsoever in taxes. My feeling was, Why should I waste time thinking about taxes? As a single, renter with no kids, I would get absolutely no deductions or credits — and in addition to that, I had nothing to itemize. That meant I should have just filled a 1040EZ and been done with it, right? Right?

Most of us who are starting our financial journey think this. It is not always true. The assumption that paying attention to taxes at this stage provides little benefit, can result in us losing out on a lot!

That is why I decided to write this post, focusing on people in their 20s — to get their attention, and to tell them there are reasons to take a second look at their taxes (though taxpayers of any age can equally take advantage of these deductions/credits).

A lot of tax software programs do guide you through these deductions. That, however, won't be of any help if you decide it isn't worth the time to go through the more time-intensive versions of the tax software and opt instead for the free EZ version. Others choose to go to one of the tax shops that crop up during tax season without realizing most of them are more interested in selling you a loan rather than doing your taxes correctly.

Which Tax Deductions or Credits Can You Claim?

1. Moving for a new job: This is one of the most common expenses for new graduates who are starting their career. You don't need to itemize to deduct your moving expenses. According to the IRS, you can deduct your moving expenses if you meet all three of the following requirements:

  • Your move is closely related to the start of work.
  • You meet the distance test.
  • You meet the time test.

If you move more than 50 miles for a new job in your field, you will most likely pass this test and qualify for a full deduction. This is an awesome deduction because it is an “above-the-line deduction,” which means it will directly reduce your adjusted gross income.

2. Tax-efficient investing within your 401(k)/IRA: You might have already heard the advice to take advantage of your 401(k) and/or IRA — Roth or traditional depending on your income. But why not take it a step further and do an audit to make sure you are investing in a tax-efficient way within your 401(k) or IRA?

As a good rule of thumb, high-yield investments or investments that produce high dividends should be in an IRA/401(k) whereas low-yield investments, tax-exempt bonds and international investments (if you pay foreign taxes, to take advantage of the foreign taxes paid deduction) is better placed in a taxable account. Of course, if you can contribute only to one — taxable or tax-advantaged account — max out the tax-advantaged account first.

3. Use Roth IRA to save for your first home: When I started my first job, I decided there are a lot of things to think about before retirement. Retirement was a far-away thought; I had to save for my first home, a wedding, travel, etc. If I could go back and give some advice to my 20-year-old self, I would tell her to save first in a Roth IRA. I would tell her that renting is not bad, she is not ready to buy a house if she has not saved for retirement AND saved for a down payment. If for some reason, she has to buy a house and doesn't have enough for a down payment, she can always take the principal without penalty to buy her first home. So fill up that Roth IRA pot first before other goals. Compound interest is indeed the strongest force for anyone's finances.

4. Side hustles (declaring income and deducting expenses): I didn't concentrate on anything other than my job in my 20s, but with the newest disruptive technologies like Uber and AirBnB, a lot of the 20-somethings are making money from more than their jobs. It is a very welcoming trend and also very relevant for taxes. I have heard a couple of arguments that if it is paid in cash, it need not be reported in your taxes. Wrong!

Someone also told me that if they get less than $600 from any one source, they don't have to declare it. Wrong again!!! Uncle Sam wants his money; so every source of income, whether from a traditional job or a side hustle, has to be reported. Even if you earned $10, it has to be reported. Whether you get a 1099 or not, it has to be reported.

On the plus side, you can also deduct almost all the expenses you incurred to make that money. So record every single expense and income. If it comes from a hobby, you have to declare the income and can deduct the expenses up to the amount you made with that hobby. If it comes from a business, you can deduct everything, even if it exceeds the income. (However, if you keep declaring losses year after year, the IRS might not consider that as a business, so talk to an accountant to get more clarification in this area.)

5. Interest paid for your loans (even if they are paid by someone else): Do you have a student loan that your parents made a payment on? You might think that since they paid the loan, you can't deduct it. You still could. The IRS considers that as a situation where they paid you the money and you paid your debtor. So, as long as they don't claim you as a dependent, you can claim that payment on your taxes.

6. HSA by employer: If you are eligible for a Health Savings Account, consider taking full advantage of that. It can serve you as an excellent tax saver, a lot more than just paying for your health bills. (For more info: http://www.fivecentnickel.com/2010/02/22/using-your-hsa-as-a-retirement-investment-vehicle/)

7. Early withdrawal penalties: When I started saving for my goals, I was overzealous and opened a CD for everything, as the interest rates were higher. Unfortunately, I also had to break a CD well before it matured. At the time, I didn't know that the early withdrawal penalty I incurred was tax deductible if I reported the income, which I did. If you have any kind of early withdrawal penalty and you reported the income, it might be fully deductible. (IRA withdrawal penalties don't count, however.)

8. Educator expenses: If you are a teacher, the money you spend on your class supplies (which teacher doesn't spend their own money?) is deductible up to a certain limit.

9. Lifetime learning: Many college graduates think that all the education deductions only apply to expenses incurred toward getting a degree. But the government encourages lifelong learning; so as long as you are continuing your education in the same field and it will help your career, you can deduct those expenses. You can use this interactive tax assistant tool from the IRS to figure out if your expenses are deductible and under what category they fall.

10. Consider itemized deductions as well: Finally, most people in their 20s with no mortgage assume they have nothing to itemize. It is probably true (the standard deduction is more generous than people give it credit for), but it doesn't cost you anything other than may be 15 minutes of your time to check if itemized deductions might be better for you, especially if you had:

  • any charitable expenses
  • live in a state with a very high tax rate
  • spend a lot out of your pocket for your job, or
  • even if you spent a lot in the last year looking for a job.

As I mentioned, these are some of the deductions that everyone uses automatically but misses the eyes of people in their 20s. If we are eligible for a deduction, there is no reason not to take advantage of it to the fullest extent.

What other tax deductions apply to your situation? Have you ever discovered a tax break that you were eligible for but didn't know you could have used it?

More about...Taxes, Planning

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Jason
Jason

Regarding educator deductions – teachers can’t deduct pension contributions federally (As they are already taken into consideration on your w2) but can do so in certain states. Also don’t forget to deduct union dues.

And for reporting cash income… no one with a side hustle really does this. There’s no way for the government to really track this (unless we’re talkign crazy money) and…well it’s not their’s.

Suba @ Wealth Informatics
Suba @ Wealth Informatics

Jason, We have to agree to disagree on the “no one with a side hustle really does this”. Cash, credit, stock, precious metals, bitcoin… however you get paid, income is income and it has to be reported as prescribed by the law of the land.

Jason
Jason

Right, but how far does that go? I found $10 on the ground this morning (no one else was nearby). I’m sure the government would say I need to declare that too. I also sold a powertool last year on Craigslist. This is a tool I bought with post-tax dollars and paid sales tax on at time or purchase. The tool then depreciated and I sold for lower than the purcahse price. If anyone asks me to declare the sale as income and then deduct depreciation, they are nuts. I think most people view it similiar to the situation where… Read more »

Suba @ Wealth Informatics
Suba @ Wealth Informatics

Again, disagree. First, as a resident of the state of WA, living on the border of Oregon a lot of stores closer to us are in OR. And yes, I am a nutcase who documents and pays sales taxes to WA states as OR is sales tax free. And second, I don’t think you are understanding the taxation correctly. If you paid for something with post-tax dollars and it depreciates, of course you don’t have to declare anything. On the other hand if it “appreciates”, yes that is income (the difference) and you can deduct the expenses that you incurred… Read more »

Abigail @ipickuppennies
Abigail @ipickuppennies

Suba’s right. Your tool wasn’t tax deductible because you actually lost money on it. It’s only if you profit on items, like collectibles, that you consider it income. Plenty of people with side hustles report their income. My husband was briefly a non-employee of a card shop (Magic the Gathering, etc). As in, he got paid under the table and was paid in store credit. But that’s still a form of payment, so I put it on our return. I’ve known people who even report bartering on their returns. Technically, that is a form of payment and is even listed… Read more »

Doug
Doug

If you think that no one does this, then you are mistaken. I report income from side hustles even when I’m paid in cash, and I also report sales tax due on out-of-state purchases (and pay it). I do this because I believe it’s the right thing to do. Maybe nothing bad would happen to me if I didn’t, but I try to do what I think is right even when there are no consequences for not doing so. I also think that if I didn’t pay, it would be unfair to the people who do. I don’t want my… Read more »

Panda
Panda

“And for reporting cash income… no one with a side hustle really does this. There’s no way for the government to really track this (unless we’re talkign crazy money) and…well it’s not their’s.”

Yay! Tax fraud!

Beth
Beth

I declare income from my side hustles because that’s what’s required of me as a citizen of this country.

Some people might argue against declaring the income on the basis that “well, it’s only $100 or so, who cares?” but you could also look at it from the point of view of “I’m willing to break the law/do something unethical for as little as $100”.

Debbie
Debbie

left out the saver’s credit

Suba @ Wealth Informatics
Suba @ Wealth Informatics

Debbie, I totally did! A big mistake. I will write that up (credits to you) and send it to Linda to add it to the post by tonight. Thanks!

Mike
Mike

Speaking of early withdrawal penalties, if you switch jobs and cash out your 401(k) you’ll get hit with a ten percent penalty tax (in addition to regular income tax) if you’re under 59 1/2. Lots of young people make this mistake. Instead of cashing it out, roll your money into a 401(k) with your new employer or an IRA.

Abigail @ipickuppennies
Abigail @ipickuppennies

If someone makes very little money, they should look into the Earned Income Tax Credit. Even if you owe no tax, you can get a refund.

You probably won’t qualify, but it’s worth checking.

Beth
Beth

Great list! Even for those of us who aren’t in our 20s.

In Canada, there’s also a First time donor’s super credit. http://www.cra-arc.gc.ca/gncy/bdgt/2013/qa01-eng.html

Samantha
Samantha

The job search expenses aren’t deductible if they’re for your first job ever. I’m not sure how to define this myself, but for safety I’m assuming the first full-time job out of full-time school doesn’t count.

Nick @ Millionaires Giving Money
Nick @ Millionaires Giving Money

A very informative post. A lot of these options were relevant to me when I was in my 20’s but I failed to take advantage because of poor financial education. Hopefully this post will help younger adults to take advantage of tax incentives.

Rick
Rick

Thanks for a great post! I am new to this and was wondering how you can use a ROTH IRA to save for a home (#3)? My understanding was that ROTH IRAs grew tax-free but could only be collected at retirement age (59) or you would incur a penalty. I know you can withdraw the money you put in at anytime, but what is the point of putting your money in a ROTH IRA if you can’t touch the interest?

Ben
Ben

One major tax credit that 20-somethings who don’t make a lot of money are eligible for is the Retirement Savings Contribution credit. This one requires planning ahead but if you are already contributing to a retirement account through work or a personal Roth/Traditional IRA this non-deductible credit has the potential to reduce your tax liability to 0. It may even be worth editing this article to reflect this tax credit as it is basically the only tax credit a 20-something who makes under $25k can take on their taxes.

Samantha
Samantha

@Mike and @Rick – from my understanding, you can withdraw your contributions into a Roth IRA at any time penalty-free, even before 59 1/2. You just can’t withdraw earnings. This is why Roth IRAs are being widely recommended for saving for a home down payment, or even as an alternative to traditional low interest savings accounts for us young’uns. Someone correct me if I’m wrong though!

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