For most students, filing tax returns ranks right up there with taking the world’s worst take-home test.
But for this exam, the score is measured in cash. Of course, signing a tax return does not require that “you have neither given nor received aid on this assignment or exam,” and it’s not hard to understand why students would want to pass the responsibility along to their parents.
The required reading – the Federal Tax Code and its associated regulations – is certainly not an overnight read, considering it has more pages than the Bible. A comprehensive study by the Tax Foundation found that Americans spend an estimated six billion hours dealing with tax compliance issues. Indeed, tax compliance costs Americans about 20 cents for every dollar the income tax system collects. To make matters worse, the tax rules constantly change each year.
Each person’s circumstances are different and require ample individual consideration when filing a tax return, but an understanding of common mistakes and tax planning strategies can certainly help.
“The most common error is that people don’t realize it could make a lot of sense for me to file even if I don’t have to,” said Mark Oleson, director of the Financial Counseling Clinic at Iowa State University. If you receive Pell Grant funds, scholarship money, earned more than $900 from investments or earned more than $5,450 by working during the year, chances are that you are required to file. Yet even if you are not required to file, there may be reasons why you should consider doing so. If you file, you may get a tax return check for income taxes withheld from your pay. Most college students face low tax rates and hence overpay when taxes are withheld by employers. To get a portion of the amount withheld back, one must file a return. Students also might choose to file to take advantage of certain tax credits, including the Recovery Rebate Credit.
For those without complex tax situations, the most convenient way to file a tax return may be with tax preparation software. TurboTax offers free federal filing if your Adjusted Gross Income is less than $30,000. The company also offers free state filing for select states. H&R Block TaxCut similarly offers free federal tax return filing if your AGI is less than $56,000 and you’re younger than 50 years old. These tax preparation programs will ask you the relevant questions required to discern your taxable income and the deductions and credits for which you qualify. Although it also is possible to file without the aid of software or professional tax advice, the process is often difficult and time-consuming.
The IRS income tax and wage forms themselves can be confusing, as abbreviations are often used to identify these documents. For example, a W2 form is a wage and tax statement from your employer that states your earnings and the amount withheld for taxes. A 1042-S is a wage statement for international students for any earned income. 1099-DIV and 1099-INT are tax statements that you receive from your bank indicating dividend and interest income. 1040-EZ, meanwhile, is the most popular IRS federal tax filing form that is recommended for individual filers with complex returns, while the 1040 is the full version of the form. 1040NR-EZ and 8843 are related forms that are used by international students.
Students should look into taking advantage of education tax credits and deduction, such as the Hope Tax Credit, the Lifetime Learning Tax Credit, tuition and fee deductions and student loan interest deduction. These credits and deduction often have income limits and include your parents’ income if you file as a dependent. Generally, if your parents are paying more than half of your expenses, they are entitled to list you as a dependent on their taxes. Unless you have a sizable tax bill, your parents likely will get more out of a credit or deduction than you will.
Perhaps the best tax planning strategy for students is to set up and fund a Roth IRA. Roth IRAs are retirement accounts that allow your money to grow tax free. The catch is that you must pay taxes upfront on income you deposit in a Roth IRA account. Because students generally have low incomes and therefore low tax rates, it is advantageous to pay taxes now and let the money grow tax-free over time. The money contributed can be withdrawn at any time, and earnings may be withdrawn penalty-free when you are around 60 years old.
As college students, we can look forward to a lifetime of paying taxes. If history is any indication, the time and cost of filling tax returns will increase with each session of Congress. Those students that take accountability for their own tax returns now may stand to benefit from familiarity with the tax system and the financial advantages of tax planning. It’s far easier to look at filing tax returns as an extended learning process than an exam if you begin preparing before April 15.
Rahul’s column runs biweekly Thursdays. He can be reached at r.gorawara@cavalierdaily.com.
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