Tax Planning for Your First Job
Monday, December 8, 2008; 12:00 AM
Now that you've entered the full-time workforce, you'll enjoy getting steady paychecks, and so will your partner ... Uncle Sam. Becoming a wage earner means becoming a taxpayer, too.
You'll owe federal income taxes at rates that range between 0% (on your first $8,025 of taxable income in 2008 if you're single) to 35% (for amounts over $$357,700). Social Security and Medicare taxes will claim 7.65% of your first $102,000 of salary in 2008, starting from dollar one. After that, the 1.45% part of the tax that pays for Medicare continues no matter how high your earnings. State income taxes depend on where you live.
In 2009, that wage base amount rises to an estimated $106,800. The 1.45% part of the tax that pays for Medicare continues no matter how high your earnings. State income taxes depend on where you live. But taxpaying is not all a one-way street. There are ways to save, too.
But taxpaying is not all a one-way street. There are ways to save, too.
Job-hunting expenses. Unfortunately, you can't deduct the cost of looking for your first job. When you change jobs, though, expenses such as the cost of printing résumés and travel to job interviews are deductible, as long as you're looking for a job in the same line of work. Such costs are "miscellaneous expenses," which means they are deductible, if you itemize, to the extent they exceed 2% of your adjusted gross income.
Moving expenses. You can deduct the cost of job-related moving expenses even if it's for your first job and even if you claim the standard deduction rather than iteming. The key is that your new job be at least 50 miles away from your old home. In addition to the cost of moving your household goods, if you drive your own car you can write off 19 cents a mile if you moved between January 1 and June 30, 2008, or 27 cents a mile if you moved between July 1 and December 31, 2008. (The unusual mid-year boots in the deductible mileage allowance reflects the spike in gasoline prices.) The mileage allowance for 2009 may be different.
Get withholding right. This is something most workers -- whether on their first job or 20th -- fail to do. We know that because nearly 100 million taxpayers get tax refunds every year -- proof positive that they had too much withheld from their pay. When you start a job, you'll be asked to fill out a Form W-4. That little piece of paper controls how much federal income tax will be taken out of each check for the IRS. The amount is based on your salary and the number of "allowances" you claim on the W-4. Take the time to read the instructions carefully to be sure you claim as many allowances as possible. That will hold withholding down to the legal minimum.
If you're starting a job in midyear (as college grads often do), consider asking your boss to use the "part-year method" for figuring withholding for the rest of the year. This method basically sets withholding based on how much you'll actually earn rather than on 12 times your monthly salary. That can put more money in your paycheck when you are starting out and can probably really use the dough.
Sign up for the 401(k). If your company offers a 401(k) retirement savings plan, don't hesitate to join. Most firms match part of an employee's contributions -- 50 cents on the dollar for the first 3% of pay, for example. Contribute at least enough to capture the full company match. If you join a traditional 401(k), pre-tax salary goes into the plan. If you're in the 25% tax bracket, that means your take home pay will drop by just $750 for each $1,000 you contribute to the plan. If your firm matches 50%, that means you'll have $1,500 in the plan for an out-of-pocket cost of just $750.
If your company offers the Roth 401(k) option, you may be better off choosing it. With the Roth, after-tax money goes into the plan, so a $1,000 contribution really costs $1,000. The advantage? As with a Roth IRA, all withdrawals from the Roth 401(k) can be tax-free in retirement, while payouts from the traditional 401(k) are fully taxable.
Depending on your income, contributions to a 401(k) might earn you a special tax credit, too. The retirement saver's credit is worth $200 to $1,000 for qualifying taxpayers, based on a 10%-to-50% credit on up to $2,000 that you sock away in a retirement plan. That credit, which reduces your tax bill dollar-for-dollar, is in addition to other tax savings that may apply to your retirement plan contributions. You can qualify for this credit on your 2008 return if your income is under $26,500 if you're single or if income on a joint return with your spouse is under $53,000.
Take advantage of a flex plan. Be aggressive if your employer offers a medical reimbursement account -- sometimes called a flex plan. These plans let you divert part of your salary to an account, which you then tap to pay medical bills. The advantage? You avoid both income and Social Security tax on money run through the account. Paying medical bills with pretax money can save you 20% to 35% or more compared with spending after-tax money. If you're paying for child care while you work, also take advantage of a child-care reimbursement account if your company offers one. It works the same way as the medical plan, allowing you to use up to $5,000 of tax-free money to pay for child care. If you're in the 25% bracket, you'd have to earn more than $7,400 to have $5,000 left -- after federal income and Social Security taxes -- to pay your care provider.
Enjoy tax-free fringes. Fringe benefits often deliver double benefits. Not only does your employer foot all or part of the cost, but also the value of most of these benefits comes to you tax-free. Even when the value is included in your taxable income, you come out ahead. If you're in the 25% bracket, for example, paying tax on the value of a $1,000 fringe benefit costs you just $250, while you'd have to earn $1,333 to have $1,000 left to pay for the item if you bought it with after-tax dollars.
Among the tax-free fringes you may be offered:
Medical and dental insuranceGroup term life insuranceFree parking, up to $220 in 2008, increasing to $230 in 2009.Transit passes, up to $115 a month in 2008 and up to $120 a month in 2009.Company car. The value of business use can be tax-free; the value of personal use is taxable.Child-care expenses, up to $5,000 a yearEmployee discounts on your company's goods and servicesAdoption benefits
Stock options. The chance to buy company stock at a discount can be a great benefit. But the tax rules are extremely complex, and different rules apply to different kinds of options. For incentive stock options (ISOs), for example, no tax is due under the regular tax rules in the year you exercise the options to buy stock. But, if you're hit by the alternative minimum tax (and exercising ISOs might make you a target), tax is due on the difference between what you pay for the stock and its value at the time you acquire it. No tax is due when you are granted non statutory stock options. But when you exercise the options to buy stock, you are taxed under the regular tax rules on the difference between the purchase price and the stock's value. If options are part of your employment package, make sure you understand the tax ins and outs so you can make the most out of your options.
Health Savings Accounts. HSAs are a relatively new form of medical plan that is being offered by more and more employers. They involve teaming a high out-of-pocket deductible insurance plan with a tax-free savings account. If you choose such a plan, your employer can make tax-free deposits to your HSA account, and you can withdraw money tax-free to pay your unreimbursed medical bills.
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