For the nearly 3 million young adults who graduate in 2023 with a bachelor’s or associate degree this year, there is plenty of good news as they head into the workforce.
“The labor market is strong, unemployment is low and, according to a survey by the National Association of Colleges and Employers, businesses are expecting to hire almost 4 percent more graduates from the class of 2023 than they did from the previous class,” reported The New York Times in July.
Along with the joy of the first paycheck … and second … and third … comes the reality of having to pay your share of taxes.
“If you’ve graduated from college, congratulations on the accomplishment. This is a time your financial responsibilities will likely increase, including complying with your tax obligations to the IRS,” says LendEDU. “While suddenly having to cope with tax obligations isn’t fun, the good news is, it’s common for your employer to just withhold the money you need to pay from your paychecks — as long as you complete your pre-employment forms correctly.”
What many graduates may not have realized is that their parents received a tax break until now by claiming them as dependents on their tax returns.
“Chances are good you were claimed as a dependent on your parents’ taxes while you were a college student. If you’re now on your own, you likely won’t get this tax benefit anymore,” says LendEDU. “When you’re a dependent, your parents claim you on their tax return. Your parents are eligible for certain tax credits and deductions because of your status as a dependent if you meet specific requirements.”
Of course, not every recent grad gets a job right away and many will return home and live with their parents as they transition to the next phase of their life.
The first question you will need to answer regarding taxes is whether you are self-supporting or dependent as this will affect how both you and your parents file their taxes next year.
There are two tests that could classify you as dependent on your parents' tax return: the qualifying child test and the qualifying relative test.
“Depending on your age, though, you may fall into either a qualifying child category or a qualifying relative category,” says Experian.
Overview of IRS rules for claiming a dependent
Tests to be a qualifying child:
o Under age 19 at the end of the year and younger than you (or your spouse, if filing jointly).
o Under age 23 at the end of the year, a full-time student, and younger than you (or your spouse, if filing jointly).
o Any age if permanently and totally disabled.
Tests to be a qualifying relative:
o Must be related to you in one of the ways listed under Relatives who don’t have to live with you or
o Must live with you all year as a member of your household (and your relationship must not violate local law).
Tax Tip from Accolade Financial: If your parents meet the eligibility criteria to claim you as financially dependent for tax purposes, it is usually more beneficial for them to do so rather than you claiming a deduction for yourself. Parents typically have a higher income since they are older and more established in their careers. Because of this, your parents are likely to receive a greater tax benefit from your dependency status than you would by filing independently.
W-4 forms, flexible spending accounts (FSA), 401(k)s and more – it’s a whole new financial world for those new to the workforce.
Here are some tax tips to consider:
The IRS recommends that employees check their withholding, especially for anyone whose refund is larger or smaller than expected. For those who owe, increasing tax withholding in the current year is the best way to avoid having to pay tax when filing a tax return the following year. In addition, taxpayers should always check their withholding when a major life event occurs or when their income changes.
Tax Tip: When to Check Withholding:
o At the beginning of the year ensure the withholding is correct for the tax year ahead.
o When changes in tax law affect a taxpayer's situation.
o When the taxpayer has a lifestyle or financial change like marriage, divorce, birth or adoption of a child, home purchase, retirement, or filed Chapter 11 bankruptcy.
o When there is a change in a taxpayer's wage income, such as the taxpayer or their spouse starts or stops working or starts or stops a second job.
o If the taxpayer has taxable income not subject to withholding, such as interest, dividends, capital gains, self-employment and gig economy income, and IRA distributions.
o When a taxpayer reviews their planned deductions or eligible tax credits, including items like medical expenses, taxes, interest expense, gifts to charity, dependent care expenses, education credit, Child Tax Credit, or Earned Income Tax Credit.
Tax Tip: The student loans that qualify for the interest waiver during the pandemic are any loans owned by the Department of Education. These are Direct Loans, subsidized and unsubsidized Stafford Loans, Parent and Graduate Plus Loans, and consolidation loans. The student loans that do not qualify for the interest waiver are many. They are the Federal Family Education Loans (FFEL) and the Perkins Loans if held commercially by lending institutions. If they are held by the Department of Education, they are also covered. The only student loans that qualify for the student loan interest deduction are those that are for the benefit of you, your spouse, or your dependent and spent on qualifying education expenses. Private loans or loans from an employee-sponsored plan are not eligible. The loan must be for an academic term and the student must be at least half-time to qualify.