Taxes for Students: Navigating the Maze of Deductions, Credits, and Dependencies
In 1789, Benjamin Franklin wrote to French scientist Jean-Baptiste Le Roy that, “In this world, nothing is certain except death and taxes.” While the adage held true then, it's worth noting that Franklin's words have gained recognition for its remarkable foresight, considering the significant expansion of the U.S. tax burden since those early days. Following the Revolutionary War, the predominant form of taxation was the excise tax, levied on specific goods or services, often referred to as "sin taxes" because they aimed to discourage consumption of certain products, including tobacco, alcohol and gambling. These are also sometimes called ‘hidden taxes,’ since they generally are not known to the consumer, yet are still passed onto the public in the form of higher prices for goods. Excise tax still exists today; for instance, the Inflation Reduction Act of 2022 included, among many other things, an excise tax on corporate stock buybacks and made a permanent increase in the excise tax on coal.
The tax that most people think of in regard to their personal tax obligation is income tax, and was only made legal in 1913 when congress ratified the 16th amendment. Prior to 1913, attempts by Congress to issue a federal income tax had all been struck down as unconstitutional or repealed for various other reasons. Over 100 years since income taxes were introduced, the modern tax landscape encompasses a broader spectrum, including not just individual, but also, corporate income taxes, payroll taxes, consumption taxes and property taxes. Looking at the historical progression of taxation, we can see that understanding taxes is not only a practical necessity but also a financial opportunity. This is particularly relevant for students and individuals who may be encountering income tax liability or the prospect of refunds for the first time through part-time or summer jobs.
But despite their inevitability and opportunity potential, taxes remain an enigma to many students.
To fulfill one's federal income tax responsibility, which is incumbent on any U.S. citizen earning over $600, one must file a Form 1040, the US Individual Income Tax Return Form. This can generally be filled out with information from various sources, among them the W-2 form one gets from their employer at the end of the year. It should be noted that one might have a state income liability too. People can prepare and file this by themselves, or alternatively, use online tax preparation software, such as H&R Block or TurboTax, or hire a tax preparer or CPA to file for them. Individuals earning under $73,000 can file for free online with IRS Free File, accessed on the IRS webpage.
Irrespective of one's chosen tax filing method, understanding the fundamental principles behind tax calculations can be highly advantageous. This is especially true for students, as their tax situations are generally uncomplicated and more straightforward than they will be in other stages of life. Thus, it's an ideal time to acquire a solid grasp of these fundamentals.
Before one even begins to prepare to file their income tax return, one should determine their dependency status. For students, one should speak about this with their parents. Generally, one can be claimed as a dependent for tax purposes only until they turn 19 and provide less than half their own support. However, for full time students, the dependency age limit extends to 24. Whether or not one is a dependent may have a significant impact on what they, and/or their parents, can claim as deductions and credits, which impacts the ultimate tax liability. Being a non-dependent from parents may allow students to receive more tax benefits, but this may come at the cost of benefits to their parents.
One difference between filing as a dependent or a non-dependent is the standard deduction that most US taxpayers are entitled to just for being alive. In 2023, the non-dependent standard deduction is $13,850. This number is adjusted for inflation so it most likely will go up this coming year. This means that as long as one is independent of their parents, they should be able to make $13,850 before they have to pay anything in federal income tax. For dependent children, however, this is reduced to $1,250 or their earned income plus $400, whichever is greater, as long as it doesn’t go above the regular standard deduction.
This doesn’t matter much if one has a lot of earned income, like wages or salary, but if someone has a lot of unearned income, which generally comes from dividends and capital gains from investments, this may be a factor. As an alternative to the standard deduction one can take an itemized deduction, which are deductions such as state income tax deductions, mortgage interest deduction, medical and dental expenses and deductions for charitable donations. The itemized items are then added up, and if they are greater than the standard deduction one can elect to take them instead. However, one living an average student’s lifestyle is likely to be a lot better off taking the standard deduction. One’s dependency status does not impact one’s ability to claim an itemized deduction. It should be noted that this deduction is not a credit, the difference between the two being that a deduction reduces one’s tax base, or how much income gets taxed, and a credit reduces one’s tax bill directly.
In addition to the standard deduction there are other tax credits that students can look into, and is generally applicable to many student’s parents or students paying for tuition. One of these is American Opportunity Tax Credit. This credit is available to students who are in their first four years of college and can give one a credit of up to $2,500, up to $1,000 of which may be refundable. This means that this will reduce the taxes one owes by up to $2,500, and then, if one’s tax liability is already less than that, they can get up to $1,000 from the government in excess of whatever may have been withheld from one’s paycheck. It should be noted though, that this begins to phase out if one’s income is above $80,000 and is totally inapplicable by the time one’s income is $90,000. While most students are probably not making this much, this credit is available to those who claim students as a dependent. As such, if one’s parents are making over the income limit, for married couples filing jointly the credit begins to phase out when making $160,000 and is completely eliminated when making $180,000. This may be a factor in determining whether one should file as a dependent or independent from their parents.
Another helpful credit is the Lifetime Learning Credit. This credit is worth up to $2,000, although none is refundable. Like the American Opportunity Credit, this can also be claimed by those who claim a student as a dependent, but also begins to phase out at $80,000 and is completely eliminated by the time one reaches $90,000 in income. These numbers are doubled for married couples filing jointly. It should be noted one cannot take both the Lifetime Learning Credit and the American Opportunity Credit in the same year.
To be eligible for these credits, one first must access their 1098-T to know what their education expenses are. At YU, this personalized form can be found here. Once one gets their 1098-T they have to fill out Form 8863 to receive the Lifetime Learning Credit or the American Opportunity Credit.
One’s education expenses can be further leveraged for state taxes. In New York, one can utilize education expenses to get a credit of up to $400 or a deduction of up to $10,000, which is $2,000 more than the basic standard deduction in New York. One can get these by filing out Form IT-272 and submit it with their return.
While there is a lot more to filing taxes than what’s discussed here, and no one’s taxes can be accurately described with a one-size-fits-all article, these tips should provide you with the basics needed to get started on your taxes this coming year. No matter how you choose to file, I hope this can help build your understanding of the unique benefits one can get as a student filing taxes and help smooth out the process.
The author does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
Thanks to Dr. Leonard Fuld for assistance in writing this article.
Photo Caption: College students, each year, learn to navigate the complexities of tax season, demonstrating their financial acumen as they balance books and budgets while pursuing higher education
Photo Credit: Kelly Sikkema / Unsplash