Tax Tips for the 2010 Graduate

Member Group : Lincoln Institute

Tax Tips for the 2010 Graduate

For many recent college graduates, this summer marks the start of their professional careers. And with that, comes the all-to-dreaded responsibility of preparing one’s own tax return. Many recent graduates may find it difficult preparing a tax return that will result in paying the least amount of tax. But Doug Keegan of Harris SBSB says that with a little tax planning, the 2010 graduate can save hundreds of dollars in taxes.

Doug, many recent college graduates will be entering the workforce for the first time. And many have no experience with taxes. You suggest that by planning now, they may be able to save hundreds of dollars.

That’s right, Lowman. It goes without saying that our tax laws are complex and constantly changing. It’s tough even for tax professionals to keep current let alone a recent college graduate. So what I’d like to do is provide some tax tips. The key is, as with all planning, don’t wait until the last minute. Now is the time to plan.

So what tax tips are you going to share with us?

I’d like to share 5 tax tips: (1) how to maximize your take home pay for 2010 (2) how to file early to obtain a quick refund (3) how to use "above-the-line" deductions to reduce your adjusted gross income and ultimately your tax bill (4) how to use tax credits to reduce your tax bill dollar for dollar, and finally (5) how to use retirement accounts to not only defer income taxes, but to save for retirement as well.

Let’s get started. How can the 2010 graduate maximize their take home pay for 2010?

Let’s say you start a new job in July. Despite working only 6 months this year, for Federal income tax purposes your paycheck will be converted as if you had worked all year, meaning more Federal income tax will be withheld from your paycheck than required. How does this happen? When you start a new job, your employer asks you to fill out Form W-4, which is a form that instructs them how much they should withhold in Federal income taxes from your paycheck. When filling out this form, most recent college graduates will put down 1 allowance. But as I explained, this will create an "over-withholding" situation this year. So, to alleviate this situation, the 2010 graduate should claim 3 dependents on their W-4, which will increase the number of allowances from one to four, meaning less Federal income tax will be withheld.

To give you an idea, I ran some numbers. For a recent college graduate in Pennsylvania, with a starting salary of $3,500 a month, the savings would be $156. So from July through December, that’s almost $1,000. That’s a lot of money for a recent graduate. So, my tax tip #1 is to increase the number of allowances on Form W-4 to avoid "over-withholding" in 2010. But be careful, you’ve got to remember to change the proper number of allowances starting January 2011. Otherwise, not enough taxes will be withheld for 2011. Go to to use a free online paycheck calculator to run different scenarios and better understand your paycheck.

If that scenario, can they still expect to receive a tax refund?

There’s an excellent chance that they’ll qualify for a tax refund. And this leads me to tax tip #2. Be prepared to file your 2010 tax return early in 2011 to obtain a quick refund. Most college graduates are computer savvy so I’d recommend preparing and filing the tax return online. That will shorten the time between filing and receiving a refund. Go to to learn more about online filing options. Alternatively, if you decide to use snail mail, in most IRS regional centers, the refund can be hastened by labeling the envelope containing the return "REFUND".

Let’s talk about "above-the-line" deductions. What are they and can you explain the difference between an "above-the-line" deduction and a "below-the-line" deduction?

Sure. This is an area that can get quite complex. So let me just cover the basics. An "above-the-line deduction" is a deduction taken before you arrive at your final adjusted gross income. Your final adjusted gross income is located on Line 37 of IRS Form 1040, which is the standard IRS form that individuals use to file their income tax returns. Therefore, an "above-the-line" deduction would be any deduction taken above Line 37. For recent college graduates, examples of "above-the-line" deductions include student loan interest, moving expenses, and tuition and fees if they decide to go back to graduate or professional school starting in the fall. Up to a maximum of $2,500 in student loan interest can be deducted (if not claimed as a dependent) and up to $4,000 in tuition and fees can be deducted.

Now "below-the-line" deductions are deductions taken after you have determined your adjusted gross income, meaning below Line 37. "Below-the-line" deductions can be itemized and include things like mortgage interest, state income taxes, medical expenses, and charitable donations. Since most recent graduates won’t have enough itemized deductions to exceed the standard deduction, they will make use of the standard deduction, which for single filers is $5,700 this year.

So tax tip #3 is to make use of all "above-the-line" deductions available to you.

Are there any tax credits available to 2010 graduates and can you explain the difference between a credit and a deduction?

While a deduction reduces your income, a tax credit actually reduces your tax bill, dollar-for-dollar. Obviously, a tax credit is a better deal than a deduction. For the 2010 graduate, the most likely tax credits available are the Lifetime Learning Credit or the American Opportunity Credit. The Lifetime Learning Credit is a tax credit for the first $10,000 spent in 2010 on education, whether at the undergraduate or graduate level. You can reduce your taxes by up to $2,000 as long as you paid as much as $10,000 of tuition and fees during 2010. The American Opportunity Credit can reduce your taxes by up to $2,500. And as much as 40 percent is refundable if the taxpayer’s tax liability is unable to cover the full amount of the credit. One of these credits (but not both) may be reported by either the student (if not claimed as a dependent) or their parents. If the parents paid the education bills the American Opportunity Credit should be reported on the parent’s tax return.

So tax tip #4 is to make use of all tax credits and make sure to alert your parents to the eligibility requirements that may allow the reporting of the American Opportunity Credit on their 2010 tax return.

And finally, your last tax tip, contributing pre-tax dollars to a retirement account. How can that help the 2010 graduate?

Lowman, it may seem ludicrous, or even absurd, to be discussing retirement with a 2010 graduate, but once you examine the potential benefits, it becomes a no brainer. When you save pre-tax, not only do you not pay tax on the amount saved, but any earnings on that savings grow on tax-deferred, meaning no taxes due until you make a withdrawal.

Here’s an example. Let’s say you start saving $175 a month at age 25, increasing your savings annually by 3%. Let’s also say you earn 6% annually over a 40-year period. At age 65, you’ll have saved over $500,000. But let’s say you decide to hold off for 10 years and instead start saving at age 35. You’ll have saved a little under $250,000, or about half. You see, by starting at age 25, you gave your money an extra 10 years to work for you. Those extra 10 years make all the difference in the world when it comes to the math. Think of it this way, if the math works such that every 10 years your account balance doubles, if you save over 40 years instead of 30 years, that last doubling is huge in terms of your retirement savings. In this example, that’s the difference between having $500,000 versus $250,000. That’s why I always say, let the math work for you, not against you.

So tax tip #5 is to establish an IRA (Individual Retirement Account) or similar retirement arrangement, such as a 401(k) Plan, as soon as possible. Contribute whatever you can afford. Just get started.