September 2023

10 Tax Benefits for College Students

Updated for 2023.

College can be expensive, but the IRS offers several tax benefits for college students to make higher education more affordable for Americans.

Whether you’re a parent of a college student or paying your own way through school, here are 10 important things to know about college and taxes.

At a glance:

Filing a tax return can be advantageous and get you a tax refund even if you don’t technically have to file.
Know which educational tax credits and deductions you qualify for, such as the American Opportunity Credit, Lifetime Learning Credit, and student loan interest deduction.
Utilize tax-free education savings plans like 529 plans or Coverdell accounts to pay for college expenses.

1. File even if you don’t have to.

Technically, you only have to file a tax return if you reach a certain income level.

For example, if you were a dependent who earned more than $13,850 in 2023, you’re required to file an income tax return. But even if you earned less than that, you might be due a refund if your employer withheld taxes from your paycheck.

Take some time to file, and you might discover you’re owed a tax refund — you don’t want to leave that lying on the table.

2. Consider going alone.

In most cases, it makes perfect sense for a traditionally aged college student to remain a dependent for tax purposes.

But there are certain situations where it might be advantageous for college students to file independently. For example, some higher education tax credits are only available to moderate-income earners. You might be better off filing independently if your parents earn too much to qualify for these credits. Just make sure to sit down with your parents or student and have a conversation about whether you meet the dependency requirements and how you plan on filing.

3. Check out the Lifetime Learning Credit.

The Lifetime Learning Credit is one of two tax credits available to cover college tuition. It will pay up to $2,000 per year per family to help cover qualified educational expenses.

The credit is good for every year in which a student is enrolled in college, graduate school, or part-time learning.

4. Apply for the American Opportunity Tax Credit.

The American Opportunity Tax Credit (AOTC) is even more generous, offering up to $2,500 per year per student, compared to the Lifetime Learning Credit cap of $2,000 per family.

One drawback: You can only claim it for four years per student, so there is no credit for graduate work if you choose to continue your higher education after undergrad.

5. The AOTC might pay you.

One more excellent perk of the American Opportunity Tax Credit: The $2,500 credit is refundable up to $1,000, meaning that if you have no tax liability, you’ll still receive up to that amount as a tax refund.

If you’re eligible for the Lifetime Learning Credit and the American Opportunity Credit for the same student in the same year, you can only choose one credit, but not both. If you’re trying to decide between them, typically, the AOTC is more valuable due to the higher credit amount and its partial refundability.

6. Deduct your student loan interest.

Millions of current college students and college graduates make student loan payments every month. Like mortgage interest, student loan interest is deductible up to a limit of $2,500 or the amount of interest you actually paid — whichever is lower.

Even better, you can take the student loan interest deduction even if you don’t itemize.

7. Get a tax refund for work-study.

Unlike other types of college financial aid (like grants and scholarships), the money you earn from a work-study job is considered taxable income.

But that’s not all bad.

The school will withhold income taxes from your paychecks. So, when it’s time to file your taxes in April, you will likely get a tax refund.

8. Pay college expenses tax-free.

There are two types of college savings accounts that every parent of a future college student should know about: 529 plans and Coverdell Education Savings Accounts.

In both cases, money in the accounts grows tax-free. But even better, you can withdraw money tax-free if the funds are used to pay for qualified education expenses.

9. In a crunch, tap the IRA.

It’s generally not a good idea to withdraw from a retirement account early. Not only are you taxed on the cash, but you’re also hit with a 10 percent penalty.

There’s a loophole, though, for qualified education expenses. If you withdraw money to pay for college costs, you’ll still owe taxes, but the 10 percent penalty is waived.

10. Geography matters.

If you attend school in a different state than your tax home (aka your parents’ house), make sure you pay taxes on any earnings from both states if applicable.

For example, different tax rates may apply if you have a summer job at home and a part-time job at school. You might even get lucky and work in a state without income tax. Read up on both states’ tax laws and be prepared to file twice if necessary.

This article is for informational purposes only and not legal or financial advice.

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4 Steps to Pay Off Your Income Tax Bill

Updated for tax year 2023.

Ah, the ultimate tax question: What should you do if you owe more taxes to the Internal Revenue Service (IRS) than you can afford?

Discovering you owe more tax than expected can leave you feeling defeated. Not getting a tax refund is bad enough, but finding out you owe a lot of money is even worse. Fortunately, you can pay off or resolve that federal income tax bill by following these steps.

At a glance:

Always verify your numbers to ensure your tax bill is correct.
Avoid penalties and interest by paying promptly and requesting penalty abatement if you have a history of good tax compliance.
TaxAct can help you set up an IRS installment plan if necessary.

1. Figure out how much you owe the IRS

We have a free tax refund calculator you can use to get an idea if you will owe money to the IRS this coming tax season. Of course, you won’t know exactly how much you owe until you complete your tax return.

Once tax season rolls around, read your completed tax return carefully before you submit it. Double-check to ensure you didn’t accidentally add the same income twice or to forget a substantial deduction. 

If your tax return is missing a deduction or credit you thought you qualified for, make sure you answered all of TaxAct’s questions correctly. One missed question or overlooked checkbox could cause you to miss out on a money-saving tax benefit. Always give your tax forms a second glance before submitting them to ensure you include all the correct information.

Another way to determine if something is amiss is to compare your current year’s return to your prior year’s tax return. If your tax situation did not change drastically, but your IRS tax bill did, that’s a red flag, and you should stop and investigate the change.

Lastly, if you received a letter from the IRS stating you have tax due, don’t automatically assume the IRS is correct. They can make mistakes, too. If you’re unsure, call or write to the IRS for clarification.

2. Minimize penalties and interest

Large tax bills are worse if you must pay penalties and interest on top of the original amount owed. Luckily, you can minimize these extra charges in three ways:

Exceptions to underpayment of tax penalties: Say you underpaid your taxes last year because you owed considerably less last year and were basing your payment off the prior year’s amount. As long as you pay by the tax due date, you typically won’t pay a penalty for underpayment of tax if you withheld at least as much as you owed the prior tax year. TaxAct® can help determine if the safe harbor rule reduces your penalties and interest. Simply enter last year’s tax liability, and our software will calculate for you. You may also reduce your penalties and interest using the annualized income method if you received more of your income in the latter part of the year.
Asking for an abatement of penalties: The IRS might reduce or remove penalties and interest on the penalties if you write them a letter explaining the situation. For example, if you had an unusual tax event, you made an honest mistake, or you or your spouse had a serious illness, the IRS may choose to waive the penalties. To qualify, you generally have to have a history of good tax compliance. In your letter, be sure to ask for an “abatement.”
Paying as quickly as possible: If you owe tax that may be subject to penalties and interest, don’t wait until the filing deadline to file your return. Try to send an estimated tax payment or file early and pay as much of your tax bill as possible. Remember, even if you choose to file an extension, any taxes owed are still due on the filing deadline. You are subject to those extra penalties and fees if you don’t pay your tax bill by Tax Day (typically April 15 or the next business day if it falls on a weekend or holiday).

3. Request an installment plan if necessary

If you can’t pay off your income tax bill by the time it is due, don’t avoid it. File Form 9465, Installment Agreement Request, to set up installment payments with the IRS. You can complete the installment agreement when you file with TaxAct as well. Completing the form online can reduce your installment payment user fee, which the IRS charges to set up a payment plan.

You can make payments by direct debit with your bank account, check or money order, credit card, debit card, payroll deduction, or one of the other accepted payment methods.

4. Offer in compromise

You may have heard ads from experts promising to help you settle your IRS bill for less than you owe. The IRS will indeed negotiate back taxes through an Offer in Compromise (OIC).

However, you’ll likely have to offer at least as much as your net worth, which is everything you own reduced by your debt. If you take this route, there are two options: a lump sum cash offer payable in five or fewer installments in five months or a periodic payment offer payable in six or more installments over 24 months.

An OIC is a lot like bankruptcy — you should only use it as an extreme last resort. The IRS has an online tool to help you determine if you might qualify for an OIC.

What not to do

And finally, we have a few last-minute tips on what NOT to do if you’re struggling to pay your tax bill:

Don’t use a credit card to pay your tax bill if you can’t afford it. And especially, don’t put your tax bill on a high-interest credit card. The IRS charges a far lower interest rate than credit card companies. That means you can spend more of your money paying off the balance instead of just keeping up with the interest.

Don’t take money out of your retirement accounts.If you withdraw money from a retirement account to pay your income tax bill, you may owe a penalty in addition to income taxes on that amount. By the time you pay the penalty and income tax, you won’t have as much left to pay your previous tax bill as you thought.

Don’t panic. If you play by the rules, stay in touch, and are scrupulously honest, the IRS can be a fairly reasonable creditor, despite what many taxpayers tend to believe. Focus on doing everything you can to resolve and pay off your balance due, and they won’t be your creditor for long.

This article is for informational purposes only and not legal or financial advice.

All TaxAct offers, products and services are subject to applicable terms and conditions.

The post 4 Steps to Pay Off Your Income Tax Bill appeared first on TaxAct Blog.

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3 Easy Ways to Avoid Paying a Gift Tax

Updated for 2023.

If you give away generous sums of money to a friend or family member, you may be required to pay a gift tax to the IRS.  However, with a bit of planning, you can afford to be quite generous before you must break out Form 709 to report the amount and be on the line to pay extra money.

Here are three easy ways to steer clear of the gift tax.

At a glance:

To avoid the gift tax, give up to the annual exclusion amount ($17,000 in 2023) to any one person in a tax year.
Being married doubles your giving power.
Consider spreading large gifts over multiple years to stay within the limit.

1. Double (or quadruple) your limit.

The key to avoiding paying a gift tax is giving no more than the annual exclusion amount to any person in a given tax year. For 2023, that amount is $17,000 (up from $16,000 in 2022). This means if you want to give ten people $17,000 each in one year, the IRS won’t care. However, if you give $18,000 to just one person, you must file a gift tax return.

The annual exclusion amount does rise periodically due to inflation, so it’s important to double-check the amount each tax year to ensure you don’t give over the limit.

Being married is an easy way to double your giving power, as both you and your spouse are entitled to the annual exclusion amount on a gift. As long as the gift is given from joint property, the IRS considers the gift to be half from each. Therefore, you and your spouse can give $34,000 total.

The same rule applies when you give to someone who is married. You can give an additional gift of up to $17,000 to the recipient’s spouse, making the annual limit from one couple to another $68,000 ($17,000 x 4 = $68,000).

2. Pay medical bills or tuition directly.

While giving a $50,000 check to a grandson heading off for college might seem the same as writing the check directly to the college, to the IRS, it’s very different. A check written to a college for tuition does not count as a gift for purposes of the gift tax. However, a check written to your grandson, regardless of what he does with it, is considered a monetary gift.

The same is true for medical bills. If you pay the money directly to the medical institution, it’s not considered a gift.

If you’d like to help a family member with college or medical expenses, paying the institution directly may be best to avoid extra taxes.

3. Spread the gift out between years.

If you’re tempted to give a large gift for the holidays, consider splitting the gift into two checks instead. For example, if you want to give your single adult son $20,000, first write him a check for no more than $17,000. Then, wait until the new year to give him the remaining amount.

What if you’ve already given more than the annual gift tax limit?

Don’t worry; filing a gift tax return is not difficult, and in some cases, you may not owe any tax yet.

The dollar amount exceeding the annual limit ($17,000) is added up throughout your lifetime. Anything that exceeds the yearly exclusion counts toward the lifetime exclusion. Yep, there’s a lifetime exclusion, too.

You don’t actually owe any tax on gifts over the annual exclusion until you exceed your lifetime limit. For 2023, the lifetime limit is $12.92 million per person. For most of us, that means we’re in the clear.

Want to run some numbers? Check out our handy gift tax calculator to help you determine if you’ll owe any gift tax this year.

This article is for informational purposes only and not legal or financial advice.

More to explore:

5 Misconceptions about the Child Tax Credit Monthly Payments
The perfect gift to give when you have zero dollars to spend
File an Income Tax Extension for Free
Gift Tax: The Tax Implications of Supporting Adult Children
Why Is My Tax Refund Smaller This Year?

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When Does Capital Gains Tax Apply?

Updated for tax year 2023.

You sold your house, an investment property, or something else of value. When do you tell the IRS?

At a glance:

When selling valuable assets, like real estate, you need to inform the IRS.
If you sell an asset you owned for a year or less, it’s taxed the same as ordinary income.
If you held the asset for longer than one year, you’re taxed at long-term capital gain tax rates, which are generally lower.
Yu can use other tax events like selling depreciated assets or contributing to charity to offset capital gains tax.

Should I tell the IRS if I sell my house?

When you sell a valuable asset, such as real estate, the IRS wants to know about it. In fact, for the sale of many assets, the IRS finds out even if you don’t tell them, thanks to reporting forms such as Form 1099-S, Proceeds From Real Estate Transactions.

No matter how large the transaction is or how much money you received due to the sale, you wait until you file your income tax return to report the sale to the IRS. However, that doesn’t mean you don’t need to do anything until next year. In fact, it could be an expensive mistake if you wait until you prepare your tax return to plan for any tax on capital gains.

It’s very important when you sell an asset to determine if you need to make estimated tax payments or otherwise plan for the tax consequences of the sale.

Why worry about estimated tax payments?

The IRS may require you to make quarterly estimated tax payments if you have substantial income, such as that from the sale of an asset not subject to withholding.

For tax year 2023, you may need to make quarterly payments if you owe more than $1,000 when you prepare your tax return, and your withholding and refundable credits are less than 90% of your total tax or 100% of your tax for the previous year.

If you don’t make estimated tax payments, you could face penalties and interest charges on the amount of tax you should have paid during the year.

Will you pay additional taxes because of capital gains?

First you need to determine if your tax bill will go up as a result of the sale. If you didn’t have a substantial gain, the sale may not affect your taxes much.

For example, if you sold an asset, no matter how valuable it was, for less or little more than you paid for it, there’s little to worry about. However, if you realized significant appreciation on your asset and sold it for a big profit, your capital gains tax may drastically affect your overall tax bill.

Perhaps the easiest way to find out if you owe more money due to selling an asset is to run next year’s tax numbers using our income tax calculator. Simply answer all the questions based on your expectations for the entire year. It’s all right to estimate. As you work through the calculator, you’ll be able to see how the sale affects your tax refund or the amount due.

How else can I estimate the tax on a capital asset?

Another way to quickly determine how much tax you’ll pay on a sale is to estimate the gain based on your tax rate.

If you sell a capital asset you owned for one year or less, it’s taxed as a short-term capital gain, meaning you will pay tax at your ordinary income tax rate. For example, say you sold stock at a profit of $10,000. You held the stock for six months. If your federal income tax rate is 24%, you’ll owe about $2,400 in tax on your short-term capital gain.

On the other hand, if you had the same $10,000 profit but you held the asset for more than one year, the tax rate is lower. If you are in the 24% tax bracket, for example, your tax rate on long-term capital gains is only 15%. In this instance, you’d only owe $1,500 in capital gains tax.

If you are in the 10% or 12% tax bracket, your long-term capital gains tax rate is likely 0%.

Be aware that capital gains can push you from one tax bracket to another. In that case, the entire gain is not taxed at the higher rate — only the part that is now in a higher bracket.

For example, say you are a taxpayer in the 12% marginal tax bracket before any capital gains. You sell a parcel of land that is a capital asset at a significantly greater value than your basis in the land (how much you originally paid for it). You must then recognize a capital gain from selling the land.

If the capital gain is $50,000, this amount may push the taxpayer into the 22% marginal tax bracket. In this instance, the taxpayer would pay 0% of capital gains tax on the amount of capital gain that fits into the 12% marginal tax bracket. The remaining portion of the capital gain that pushes the taxpayer into the 22% marginal tax bracket is then subject to a 15% capital gains tax.

Another caveat: Substantial capital gains can increase your adjusted gross income, possibly changing the amount of tax benefits you receive for various deductions and credits.

When to make estimated tax payments

You should generally pay the capital gains tax you expect to owe before the due date for payments that apply to the quarter of the sale.

In 2023, the quarterly due dates are April 18 for the first quarter, June 15 for second quarter, Sept. 15 for third quarter, and Jan. 16 of the following year for the fourth quarter. When a due date falls on a weekend or holiday, your quarterly payment is due the following business day.

Even if you are not required to make estimated tax payments, you may want to pay the capital gains tax shortly after the sale while you still have the profit in hand.

Making quarterly estimated tax payments

You can use TaxAct® to determine your quarterly payments and print out a quarterly payment voucher. You’ll need to print the voucher, attach a check or money order, and mail it to the IRS before the due date.

Another option is to use Electronic Funds Withdraw (EFW) to have a payment deducted from your bank account automatically. You can set this up using our tax prep software.

The IRS also has a phone system and internet site that accepts payments by credit or debit card. Unfortunately, there is an additional convenience fee for this service.

If you need to pay estimated taxes and other payments regularly, it’s worth the time required to set up an account with the Electronic Federal Tax Payment System (EFTPS), which is a service provided for free by the U.S. Department of Treasury. If you wish to use EFTPS, it’s always best to plan ahead.

Alternatives to making estimated tax payments

Instead of making estimated tax payments, you may choose to increase your income tax withholding to cover the additional tax. Try filing a new Form W-4 with your payroll department. This can be a relatively painless way to cover the additional tax. Just don’t forget to adjust your income tax withholding again after Jan. 1, when the capital gain amount is not included in your income.

Another strategy is to plan other tax events to counteract the effect of the capital gains tax.

For example, you may want to sell an asset that has gone down in value, make a business investment, or contribute to charity during the same year as the sale. Losses on investments are first used to offset capital gains, which means the less tax you’ll pay on the capital gain.

However, it’s important to note losses must first be deducted against capital gains of the same nature. For example, you must deduct short-term capital losses against short-term capital gains before you can use them to offset long-term gains and vice versa.

Additionally, you can only deduct up to $3,000 of net long-term capital losses in a given tax year. Any excess net long-term capital losses can be carried forward until there is sufficient capital gain income or the $3,000 net long-term capital loss limitation is exhausted.

This article is for informational purposes only and not legal or financial advice.

All TaxAct offers, products and services are subject to applicable terms and conditions.

The post When Does Capital Gains Tax Apply? appeared first on TaxAct Blog.

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