Move to a new state? Get a bump in income or a change in retirement savings? Maybe you had a signing bonus?
If you graduated recently, chances are some of these things happened to you last year and each of these milestone events could affect you when filing taxes. Likewise, if you’re expecting to graduate in the coming year and one of these following scenarios may be on your horizon, you can take steps now to minimize your tax load when filing taxes next year.
We spoke with Gil Charney, director of the Tax Institute at H&R Block in Kansas City, Mo., about how new graduates and young professionals on the move can navigate the following common scenarios when it comes to their taxes.
You Moved from One State to Another
Maybe you lived in North Carolina for five months of the year, and California for seven months of last year. You will need to file state income tax returns for both states.
Your first step, depending on the states where you lived, is to learn each state’s rules on residency, as you may find that you are a resident in one state but a nonresident or part-year resident in the second state.
“Part-year residents will most likely need to allocate income and deductions based on their days of residency,” Charney says. If you need help determining your residency status in multiple states, consult a tax specialist or tax preparation software.
Individuals should complete the non-resident state tax return first, as the tax liability to that state (not the taxes withheld in that state) can only be determined after completing that state’s tax return.
Moreover, make sure to learn about the many different credits that states offer, Charney says. Ignoring a credit that you qualify for for could result in a higher balance due or lower refund than if the taxpayer were aware of the credit, qualified for it, and claimed it.
Take note that states have become very sophisticated in matching tax documents shown on the federal form, Charney says. “If there is any omission or unexplained discrepancy on the state return, the taxpayer should expect a notice from the state’s department of revenue.”
You Had a Big Jump in Income
“Let’s say a student with zero income lands a high-paying job on Wall Street,” Charney says. “Their income will shoot up but so will their tax liability.”
While it may be too late to do anything for your 2015 income, you can still take steps for 2016 to ensure you’re doing all you can to lower your taxable income.
“Look for ways to lower your taxable income.”
“Look for ways to lower your taxable income, such as enrolling in their employer’s 401(k) plan or contributing to an IRA,” Charney says. “This not only protects current income from taxes but is the starting point in accumulating assets for a comfortable retirement.”
Also, note that a big jump in income could mean that you’re no longer eligible to use a Roth IRA.
Once you hit $116,000 in income, your ability to contribute to a Roth starts phasing out until $131,000, when you’re no longer eligible to contribute to one. If you contributed to a Roth before you got a salary bump for the year — don’t worry, you can re-characterize your contributions or remove them so that you do not get penalized by the IRA. You can read more about the IRS guidelines for Roth contributions here.
You Had a Signing Bonus
If you received a large signing bonus or end-of-year annual bonus, remember those could easily jettison you into a higher tax bracket. Even if you used the money to do something virtuous — like pay off your student loans faster — you’ll still be taxed on that additional income.
Now for future planning: If you know you will be getting a bonus as a one-time event this year, hold off on doing anything else that will add more income to your tax situation for that year, such as selling investments. Long-term capital gains are taxed at 20% for taxpayers in the highest tax bracket.
“In a situation like this, the taxes must be paid, but if the taxpayer has any control over when the bonus is paid or how it paid out, some tax planning could help him avoid a bigger tax bite,” he says.
You’re No Longer a Dependent
“For many new graduates, the biggest surprises may be that they are no longer dependents of their parents and that they are responsible for filing their own tax returns!” Charney says.
New graduates who suddenly find themselves with significantly more money will need to plan for paying taxes on that income, and to the extent they can put that income in tax-favored plans, they should do so.
If you’re entering the workforce for the first time, get help completing a W-4 with your employer to ensure you’re using the right withholdings for your situation.
“Although the W-4 can be completed at any time, it is often ignored or forgotten, with the taxpayer’s withholdings significantly over or under their ultimate tax liability,” Charney says.
You Moved for Your Job
If your new job is more than 50 miles from your old home and job — and you moved to be closer to it — you may be able to deduct qualified expenses related to that move.
Here are the rules: In order to deduct moving costs, the distance between your new job location and your old home must be greater than 50 miles over the distance between your old home and old job location. Also, you must work full-time in the general area of the new work location for at least 39 weeks during the 12 months after your move.
Qualified moving expenses include reasonable expenses to move you — and your family — from one residence to a new residence. These include, but are not limited to, transportation costs, lodging (but not meals), storage, and even the cost of moving pets.
“Expenses must be reasonable,” Charney says. “For example, the taxpayer cannot deduct the cost of a luxury hotel for five nights during a move from Kansas City to Chicago, or a personal sightseeing trip while driving coast-to-coast to move.”
Be sure to look at the IRS Publication 521 for more details on what expenses are legit deductions.
You Brought in Rental Income
Anyone who has rental real estate income from an Airbnb tenant — or from any other tenant for that matter — must report that income unless the rental period is less than 15 days during the year, Charney says.
The nature of the rental will affect how it is reported, as well as the extent that rental expenses can be deducted.
“These can get complicated and are covered under what is known as the ‘vacation home rules,’” he says. “These rules cover how a rental day is counted, which expenses can be deducted from rental income, and how the allocation between personal and rental days is determined.”
Individuals who use Airbnb to find tenants for their home or apartment will receive Form 1099-K (and/or Form 1099-MISC) from Airbnb showing the amount of rent paid to the taxpayer. Consult a tax professional to determine how the rental income and any deductible rental expenses should be reported.
You Had a Side Gig
Generally speaking, if you do work on the side on a regular basis — aka you have a second gig — you are considered an independent contractor by the IRS and will likely receive a 1099 form.
If you drive for Uber, for example, the reporting can get a little complicated. An Uber driver will receive a 1099-K (Payment Card and Third Party Network) from Uber. This form is used to report payments received from riders, such as fares, and any expenses that Uber paid on behalf of the driver, such as tolls or airport fees (which is considered income, but can also be deducted).
The driver may also receive Form 1099-MISC from Uber. Uber will report any non-employee compensation they pay directly to the driver, such an incentive payment or referral payment.
A few considerations for gig workers, according to H&R Block:
- Keep excellent records to support income and any deductions you take against your business income. Any ordinary and necessary expense incurred to carry on or support that business is deductible.
- Because you are self-employed, they must pay SE (self-employment) tax, which is reported on Schedule SE. This tax includes both the employer and employee portions of FICA tax – Social Security and Medicare taxes based on your earnings. Generally, the combined (employer and employee) rate for a self-employed taxpayer is 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare.
- To deduct business expenses against “gig” income, you should be able to demonstrate you are operating a business, and not a hobby. That’s typically defined by your profit motive, the amount of time dedicated to the activity, whether you conduct the activity in a businesslike manner, such as keeping a separate set of books, bank account, etc.
You Received Special Training for Your Job
This is often an area of confusion for taxpayers, Charney says. The reason is that to be deductible, the education must be required by the taxpayer’s employer or by law to maintain the taxpayer’s job or credentials, or the education maintains or improves the taxpayer’s skills in his present job.
“For example, an accountant may need to take training on new accounting standards to properly report his employer’s business transactions,” he says. “A mechanic may need to take a course or special training to perform her job properly. So, the education is not unlike any business deduction that is incurred to support the business.”
Any education that prepares the taxpayer for a new career is typically not deductible as an employee expense. If you’re in a lower income bracket, there are additional education tax credits that could apply to your situation.
Make sure to take a look at IRS Publication 970 for more information about tax benefits for education.
You’re Paying off Student Loans
Graduates can deduct student loan interest up to $2,500 on a qualified loan — as long as your modified adjusted gross income (MAGI) didn’t exceed $80,000 as a single/head of household filer or $160,000 as a married couple filing jointly in 2015. This is an above-the-line deduction, meaning that itemization is not needed, he says.
Phew, it’s a lot to think about it. If you have already filed your taxes for 2015, congratulations! If you’re still working on them, remember the filing deadline is April 18, according to the IRS.
No matter what, if you know you’re likely moving or getting a new job this year, you can take smart steps to make sure your tax situation is as good as it can be when it comes to filing next year.