The College Grad Guide to Taxes (Part 2): The Tax Triad

The Three Tax Components:

You now know what taxes are and which taxes you are going to be paying in the coming years. This next section will be going over the basic categories of your tax returns. In their simplest components, all documents that will eventually be summed up in your tax return can be split into three distinct categories: Income, Credits, and Deductions. Let us go over what each category is and the implications of them.

Income:

Income reflects the amount of gain or loss you have received over the course of the calendar year; not all income is treated or taxed the same, however. Active income and passive income are the two categories in which income can be dividends. Your active income is all the fiscal gain you earn during your daily occupation. This category of income is taxed at your standard tax rate which was discussed in part one. Passive income is generated from interest-bearing bank accounts, dividends from stock ownership, and any additional income earned through investment vehicles. Passive income is subjected to a lower tax rate and is thus a more advantageous source of income.

The supporting documents for your income will come from your employer, fiduciary entities such as banks, and credit unions, in addition to any investment vehicles you may use. You can expect these to be available to you in the early part of the year from January to February. Certain income documents, such as 1099s (these will be covered in greater detail shortly), are not available until after the April 15th deadline once their organization of origin has filed their respective tax return. If this happens to be the case, you will be advised to file an extension to the October 15th deadline.

Credits:

Tax credits count dollar for dollar against your tax liability. These can be divided into two categories, refundable tax credits and nonrefundable tax credits. Certain tax credits are refundable if your tax liability is less than the amount of the refundable credit and your prepayments. The difference between these two is added to your refund check. For this reason, taxpayers who are not required to file or did not file a tax return may still want to do so to claim refundable tax credits. Nonrefundable tax credits, on the other hand, will not be added to your refund check once your liability is zero.

Common tax credits for college graduates include the following:

• Child Tax Credit
• Child and Dependent Care Credit
• Earned Income Tax Credit (EITC)
• Retirement Savings Contributions Credit
• The American opportunity credit.
• Lifetime learning credit.

We will be covering these common credits in greater detail in a later section of the series.

Deductions:

There are two different paths that you can go with when choosing which deductions to go with.

Standard Deduction:

The Standard Deduction is a predetermined amount set by your filing status. There are additional standard deductions if you are blind or older than 65 years of age. For tax year 2023, the standard deductions are below:

$27,700 – Married Filing Jointly or Qualifying Surviving Spouse

$20,800 – Head of Household

$13,850 – Single or Married Filing Separately

Itemized Deduction:

To itemize your deductions can be beneficial or required if you meet the following criteria:

• Your standard deduction is reduced because you are being claimed as a dependent.
• The amounts listed on Schedule A on your 1040 are more than your standard deduction.
• If you are married and choose to file as Married Filing Separately and your spouse chooses to itemize. In this case, you must also itemize your deduction.
• If you are a nonresident alien or a dual-status alien.

We will go over itemized deductions in the latter portion, as there are several nuances to itemized deductions. For those who do not have a large yearly contribution or are currently paying a large mortgage, the standard deduction will be more advantageous in most cases and you will not need to worry about itemized deductions.

Conclusion:

These sections covered the basic portions of what makes up a tax return, your income, tax credits, and tax deductions. We will be going into a deep dive into each of these sections over the next three weeks, starting with income and what to be on the lookout for in the upcoming months.

Resources:

Tax credits for individuals: What they mean and how they can help refunds | Internal Revenue Service. (n.d.). Www.irs.gov. https://www.irs.gov/newsroom/tax-credits-for-individuals-what-they-mean-and-how-they-can-help-refunds

Topic No. 501 Should I Itemize? | Internal Revenue Service. (n.d.). Www.irs.gov. https://www.irs.gov/taxtopics/tc501