Completing your tax return can be tough and may feel like getting caught in a tax tornado of deadlines, deductions, credits, withholdings, income, and schedules. So, what does a millennial need to know going into tax season to avoid getting blown away? The answer is quite a bit, which is why it is helpful to speak to a financial planner or a tax preparer to see your situation would be best handled by a tax professional or if it’s something you can manage yourself. The following list includes common tax challenges that millennials may run into during tax season.
- You should always explore which filing deduction is best for you: itemized or standard. The standard deduction for a 2019 tax return is $12,200 for individuals and $24,400 for married couples filing jointly. If you own a home and/or contribute to charity and think your itemized deductions will be greater than these amounts, it may make sense to itemize deductions. This could make a significant difference and lead to tax savings by just taking the time and calculating your deductions.
- If you are paying off student loans, take advantage of deducting the loan interest. This may not reduce the emotional strain of paying the loans, but it may help reduce your taxes. Based on current laws, you can deduct up to $2,500 of interest you paid on an eligible student loan.
- Millennials are constantly on the move. Moving expenses may be deductible if the move was related to a job change.
- If you have a child, make sure to look into the Child Tax Credit and the Child and Dependent Care Tax Credit.
Withholding the Appropriate Amount of Taxes
- If you are a W-2 employee, be sure to adjust your tax withholdings from your paycheck to closely reflect your tax liability, which is the total tax you are responsible for paying for the year. One way to do this is look at your tax liability from the previous year and make sure you are withholding at least that amount and possibly more to account for pay raises and bonuses. This won’t help you for the current tax year but will avoid repeating some of the same issues you may find during this year’s tax return.
- After the Tax Cuts and Jobs Act (TCJA) of 2017, many people were surprised during the 2018 tax filing period to find that their tax withholding wasn’t sufficient to cover their tax liability due to changes in the tax law. Many people still have not changed their tax withholdings. In some cases, even having zero exemptions applied to your paycheck may not be enough. Use the IRS calculator periodically during the year to see if you’re on track so there aren’t any big surprises at tax time. Who knows, maybe you are withholding more than needed and can update the amounts to give yourself a “raise.” Use this link to help: https://www.irs.gov/individuals/tax-withholding-estimator
- While you may enjoy getting a large refund at tax time, it is an indication that you withheld too much in taxes. This is money you could have otherwise invested or kept in savings earning interest, so getting your withholdings right can help.
Other Sources of Income
- If you have a side business or new venture, there may be tax benefits to setting up your own business entity or retirement plan. If this is the case, contact your financial planner to understand your options.
- You may need to pay the IRS in quarterly tax payments if you expect to owe at least $1,000 in federal income taxes for the year, especially if you are an independent contractor or if your new business is starting to earn income.
Contributing to a Roth vs. Traditional IRA or 401(k)
- Reducing tax is great, but what about paying more tax now to save later? It might be a great time for you to contribute to your Roth IRA or Roth 401(k) through your employer, which uses after-tax dollars. Paying the taxes now while you are in a lower tax bracket may help you down the road when you are withdrawing these funds in a higher income tax bracket. You have until April 15th to contribute to a Roth IRA for the previous year if you are within the income limits.
Filing on Time
- This piece of advice may sound oversimplified, but it happens all the time. People tend to put off taxes because they aren’t fun to do. April 15th is the first tax filing deadline and you must submit EITHER your tax return or at least apply for the extension to file your taxes by this date. Failing to submit your taxes on time can lead to penalties which are a waste of your money.
- While filing an extension gives you an extra six months to complete your tax return, we would not recommend doing so if it can be avoided. If you owe taxes, the IRS requires that you still pay by the original April 15th due date and you may be subject to penalties, so extending your taxes doesn’t extend the date your payment is due.
Contributing to a Health Savings Account (HSA)
- An HSA is a great vehicle to reduce taxes. You can deduct up to $3,500 of contributions for single coverage or $7,000 for family coverage for the 2019 tax year. Any withdrawals from the contributions are tax free for qualified medical expenses. If you don’t use all the funds during the year, they can be used in subsequent years or invested for the future. Note that you must be enrolled in a high deductible health plan to be eligible to contribute to an HSA.
If You Have a Tax Refund, Use it Wisely
- Being young does not excuse you from making smart financial decisions. Instead of using any tax refund frivolously, use it to pay down high interest debt, build your emergency reserve, or invest in your future. The decisions you make now with your excess income can make a tremendous impact on your financial future. This is the time to build your financial foundation and put away as much as possible. These savings will receive compound growth for years to come.
This short list illustrates just some of the tax issues that many millennials face. There are many other strategies, ideas, and tactics to consider when going through the process of filing your tax return. Consider talking with a tax professional before filing on your own as you may be missing out on some savings if you are not fully aware of all the options available to you. If you want long-term strategic advice on how to lower your taxes and/or maximize your cash flow, give CCMI a call to help you get on the right path to proactively plan for future tax years.
CCMI provides personalized fee-only financial planning and investment management services to business owners, professionals, individuals and families in San Diego and throughout the country. CCMI has a team of CERTIFIED FINANCIAL PLANNERTM professionals who act as fiduciaries, which means our clients’ interests always come first.
How can we help you?