6 Most Common Tax Mistakes 20-Somethings Make, According to a CPA
Though being in your twenties is often portrayed as a glamorous and exciting time, it’s also a time when you make a lot of mistakes — including when it comes to your taxes. Like any other area in life, you can learn from those mistakes. You just have to know what they are first.
Read More: The Side Hustler’s Guide to Paying Taxes Without Crying (Much)
For You: 5 Signs You’re Losing Money Every Month — and How To Find the Leaks
MoneyLion figured there was nobody better to explain which tax mistakes twentysomethings are more vulnerable to than Kyle Paxton, tax director at James Moore & Co.
“Your 20s are full of firsts — first job, first apartment, first investment account, maybe even your first side hustle,” he said. “But they’re also when I see some of the most avoidable tax mistakes happen.”
1. Ignoring 1099 or Gig Income
Twentysomethings are a hard-working cohort. Whether they’re driving for a rideshare company, selling their creations on Etsy or even consulting, they love a good side hustle. What they don’t love is getting surprised by owing hundreds — or even thousands — of dollars come tax time.
Here’s Paxton’s quick and easy guide for freelancers or anyone with side income:
Set aside 20%–30% for taxes
Track expenses
Consider making quarterly estimated payments
“Ignoring this is the fastest way to an unexpected tax bill,” he said.
2. Forgetting To Track Expenses
There’s a reason Paxton is so eager for young people to track their expenses — and it’s not because he wants them to get better at penmanship.
“Side income without expense tracking is overpaying in disguise,” he said. “I often see young entrepreneurs leave money on the table simply because they didn’t track expenses throughout the year.”
Freelancers and independent contractors may be able to deduct ordinary and necessary business expenses. Document things like business mileage, home office space and software subscriptions, since they can be legitimate deductions.
3. Missing Education Credits
Whether you’re still hitting the books or you’ve already walked across the stage in your cap and gown, you might benefit from education credits. But you have to actually take advantage of these credits first — something Paxton says too many twentysomethings just don’t do.
“The American Opportunity Tax Credit and Lifetime Learning Credit can reduce your tax bill dollar for dollar. But eligibility phases out at certain income levels, and timing matters,” he said.
The American Opportunity Tax Credit is generally available for the first four years of higher education, while the Lifetime Learning Credit can apply to undergraduate, graduate and professional courses.
4. Not Understanding How Withholding Works
As newly minted grown-ups, a lot of twentysomethings don’t understand how certain tax basics work. For instance, they might not know that the Form W-4 they submit to an employer helps determine how much federal income tax is withheld from their paycheck.
Paxton also wants twentysomethings to understand that big life changes — like getting a new job, moving states or adding a side hustle — may mean their withholding no longer matches their situation.
Oh, and he also has some unfortunate news about those large tax refunds you and your friends are likely so excited about.
“Large refunds often mean you overpaid during the year,” he said. “Owing unexpectedly means you underpaid. Neither is ideal without planning.”
5. Overlooking Retirement Contributions
When you’re young and strong — and your back isn’t groaning at you every morning — your retirement accounts are some of the last things on your mind. However, Paxton wants you to think ahead, since “this is when tax-advantaged growth matters most.”
He says contributing to a traditional IRA, which can reduce your taxable income in the year you contribute, or a Roth IRA, which offers tax-free qualified withdrawals in retirement, is one of the smartest moves twentysomethings can make.
“I rarely see people regret starting early,” he said.
6. Assuming Crypto and Investment Gains Aren’t Taxable
Young people are excited about crypto and investing. Learning the ins and outs of selling stocks or trading crypto is fun. But as they get lost in the excitement, many twentysomethings forget that actions like selling stocks, trading crypto or cashing out an exchange-traded fund are taxable events.
“Many young investors assume that if they reinvested the money or only made ‘a little,’ it doesn’t matter,” Paxton said. “It does. Brokerage platforms report activity to the IRS.”
He’s blunt about the best course of action: Even small capital gains must be reported correctly.
The Bottom Line
Ah, youth. It doesn’t have to be wasted on the young if you can get your financial house in order — and that means knowing which common tax mistakes to avoid.
“Your twenties are when financial habits are formed. Getting tax compliance right early helps you avoid penalties, stress and missed opportunities later,” Paxton said. “The earlier you treat your tax return as part of your overall financial strategy, the better positioned you’ll be in your thirties and beyond.”
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal, or tax advice.
More From MoneyLion: