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The Ultimate Tax Filing Guide For A Mid-20s Employee

Jerry Zhang
Jerry Zhang
·

8 min read

For reference, I'm a USA tax-payer in my mid-20s and an employee. If you have a similar profile, I hope this info can be helpful for you. Bear in mind that I'm not a tax professional so if you want professional help, please seek out professional opinion.

I won't be showing any numbers due to privacy reasons. I also omitted the institutions from which I received tax documents. But as much as I can, I'll be transparent about the following:

  • How I organize my tax documents
  • What software I use
  • The tax documents I've received over the last 6 years
  • My income streams
  • My deductions

Furthermore, I'll also comment on how my taxes have changed over the past half-decade and how I foresee them to change in the future.

Okay, let's dive right in.

Organizing My Tax Documents

If you've worked for any employer or signed up for any bank/brokerage, they require a mailing address. That's because those entities are legally required to prepare your tax documents, which they'll mail to you by January. (For 2020 taxes, you'll get your forms by January 2021)

I recommend keeping all your tax documents organized in once place. The IRS recommends keeping record of your tax documents for 7 years.

Here's all my tax documents from the past half-decade:

All My Tax Documents Over The Past Half-Decade

I organize my tax documents by year. When I receive a digital document, I'll rename it to <Year> <Tax Document Type> <Entity>. Tax document types range from 1095, 1098, 1099, W2, etc. Entity would be the company name or the financial institution that gave you the document.

If I receive a physical document only (this can happen if you are no longer with the company or financial institution but still worked for them or did business with them), I'll scan the document and name it the same way.

For those of you with a sharper eye, you might notice that I'm missing some documents. Admittedly, this is due to me not being organized in the past, which is why I'm missing my W2 from 2015 and 2016.

Tax Software I Used By Year

Year Software Reason
2015 TurboTax It was still free for me since my taxes were simple.
2016 TurboTax It was still free for me since my taxes were simple.
2017 TurboTax It was still free for me since my taxes were simple.
2018 FreeTaxUSA TurboTax was no longer free for me. Plus, I learned of this.
2019 CreditKarma They offer free federal AND free state.
2020 CreditKarma They offer free federal AND free state.

Now, you technically don't need to file taxes with software. You can mail it in directly to the IRS the old-fashion way (don't forget state), hire an accountant to do it for you, or e-file to IRS as well (don't forget state). For state, it depends on your state.

But taxes (in the US) are complicated, so software helps us reduce error and maximize our returns.

Now, time for a strongly charged personal opinion: I strongly recommend against using TurboTax. They are evil, unethical, lobby to make taxes more complicated so they can stay in business, and everything else bad. You can read all about it here.

On the other hand, FreeTaxUSA and CreditKarma are both pretty great. FreeTaxUSA has free federal filing and charge $12.95 for state filing. If you live in a state without income taxes, it's ideal. CreditKarma offers filing both federal and state for free.

Unfortunately, Intuit (the company that makes TurboTax) acquired CreditKarma. Thankfully, they've allowed CreditKarma to oeprate separately, so CreditKarma is free. That being said, I'm wary if Intuit decides to try and monetize CreditKarma's tax software. For now, I'm okay with using CreditKarma.

Types of Tax Documents

Any income that you make is taxable. Any loss that you take is deduct-able. You know, big brother wants its share, but they'll play it a little nice when you're down on your luck.

Here are the types of tax documents that I've encountered so far:

  • Ways you made money
  • Ways you can deduct from your taxable income
  • Ways you can get tax credits (rare)

Ways I Made Money

Employee Wages

As an employee, I receive a W2 from my employer every year. All of my wages are taxable, and I can't make any work-related deductions.

Unless you have a non-standard way of earning money, most of your income will likely come from your employee wages. And since I'm an employee, I don't get to deduct any business expenses because the business is supposed to fully take care of me.

If you're a contractor instead (like an independent consultant or an Uber driver), you'll most likely get a 1099. You may not get benefits, but you get to deduct business expenses.

Interest

I have a high-interest savings account which pays up to 2% interest, depending on the state of the economy. (Unfortunately at the time of this writing, it sits at 0.5%.) I received a 1099-INT from my bank about this. Any interest savings I make will count as my income and will be taxed accordingly.

I also opened up some checking accounts to receive a bank bonus. These bank bonuses are counted as interest and I also received a 1099-INT from these banks I churned. This also counts as income and will be taxed as so.

Investments

I have brokerage accounts where I invest in the market. I invest in stocks, mutual funds, index funds, real estate investment trusts (REITs), and peer-to-peer lending.

I received 1099-Composite documents from all of them. Within them, there can be any combination of:

  • 1099-DIV: any dividends received from investments
  • 1099-INT: any interest received from investments, including from idle money in the brokerage account
  • 1099-B: any contracts executed between you and the brokerage
  • 1099-MISC: anything else that doesn't fit into the above categories

I know there are more since taxes can get endlessly complicated. But these were the main ones I received.

In summary, dividend and interest counts as income and will be taxed like income. Short term gains (if you buy stocks, hold for less than a year, and sell them for a profit) counts as income. Long term gains (if you buy stocks, hold for over a year, and sell them for a profit) are taxed at much more favorable rates.

My investment portfolio is beyond the scope of this article, but if you're curious about it, let me know and perhaps I can write about it some other time.

Ways I Deducted From Taxable Income

By default, everyone is entitled to claim a $12,000 standard deduction from their federal taxes. Yay, thanks big brother for giving us a nice head start.

However, if you have a lot of itemized deductions, you might be able to deduct more than the standard deduction. However, you can only choose either standard deductions or itemized deductions, not both. Therefore, it's in your interest to choose the one that is higher.

In my case, my itemized deductions exceed that of the standard deduction. Here's my list of itemized deductions:

Property

Because my home is a residential property, I can claim mortgage interest as an itemized deductions. My mortgage company gave me Form 1098, which contains the interest they received from me for this year.

Because I put a down-payment of less than 20% when I bought my home, I have to pay PMI (private mortage insurance). Form 1098 contains this information too, and I can claim this as an itemized deduction.

Taxes

The total amount of taxes I'm allowed to deduct is $10,000. This includes any state income taxes and property taxes.

Since I live in the state of CA–which charges pretty high income tax–I get to deduct my state income tax from my federal filing.

Furthermore, since I own property, I can deduct the property taxes that I paid for the year.

Gifts To Charity

Giving is good for both the organization that received your gift and for your taxes. Because I made gifts to non-profits, I can deduct the full amount that I gave.

Other Common Deductions

Student loan interest. If your income is below a certain amount, you can deduct this.

Ways I Received Tax Credits

I didn't receive a tax credit in 2020, but I did receive a tax credit in 2018 when I purchased an electric vehicle. I had to file Form 8936 and received $7,500 in tax credits that year.

Note that this is different from a deduction. A tax deduction reduces the amount of your taxable income. A tax credit reduces the amount of taxes you need to pay.

A Quick Primer on Tax Credits vs Tax Deductions

Tax credits can either be better or worse than a deduction, depending on your situation. For example, if I'm required to pay $10,000 in taxes for a given year and I have a $7,500 tax credit, I would only need to pay $2,500 in taxes. But, if I'm required to pay only $5,000 in taxes for a given year, my taxes owed would be $0, even if my tax credit is $7,500. The extra $2,500 goes to waste and can't be carried over to the next year.

Tax deductions affect the amount of taxable income. If I made $100,000 and deduct the standard amount of $12,000, that means instead of my full $100,000 being taxable, only $88,000 is taxable.

How My Taxes Have Changed Over The Years

My taxes have definitely gotten more complicated over the years. When I was just a student in school and a newly minted professional, I only had wages.

As time went on, I started investing in various assets, such as stocks, REITs, P2P, etc. This changed my tax structure a little, but not too significantly.

It wasn't until I bought property and an electric vehicle that I started unlocking new interesting tax deductions.

Generally speaking, the more types of assets you own, the more complicated your taxes will be. This isn't a bad thing–it just means you unlock more types of deductions.

Potential Future Changes

Will I Stay An Employee?

Right now, most of my income comes from my wages as an employee. My W2 supplies the bulk of it.

Will I stay an employee forever? Who knows. Being an employee is nice because I get job security and nice benefits. However, it comes at the cost of capped earnings and inflexibility of time. I pretty much have fixed work hours, and I'm trading time for money.

The other option is to be a contractor, which comes with the double-edged sword of higher risk for potentially higher reward. Job stability is no longer a thing, but if you're good and you work fast, your earnings can exceed that of an employee for the same amount of time put in. I could also choose to work less for less money if that's the lifestyle I want.

The freelancing scene has never been stronger, and there's a non-zero possibility I might take that plunge.

From a tax perspective, this means I'll forgo my W2 for a 1099. Furthermore, I'll get to make business-related deductions for equipment, travel, etc. More deductions, but also more responsibility, like paying for my own social security tax.

Will I Install Solar?

The federal government recently extended the incentive tax credit (ICT) for solar panels to 2023. I am seriously considering installing solar panels on my roof to take advantage of clean energy, lower electricity costs, and of course the tax credits. If I act within this time frame, I could get 26% or 22% in tax credits.

Will I Buy More Property?

I love real estate as an investment. It's stable, predictable, and always in-demand. The number of people will always increase, but the amount of land always stays the same (unless we successfully colonize the moon or Mars).

If I do end up buying more property, they would be classified as investment properties, which would introduce a lot of interesting deductions for me. I might even put the property under an LLC to take advantage of having an extra layer of legal protection and unlock other tax benefits.

Conclusion

Taxes (in the US) are complicated. But the complications aren't exactly meaningless. I think they help us out if we take the time to understand the rules and know our options.

By reading through my tax forms, I'm not only able to understand my taxes, but I'm also able to identify future opportunities that are benefitial from a tax perspective.

Nobody likes to pay taxes, but the government (federal, state, and local) need money to operate. Of course, they could be more efficient with their money, but they did get us this far. As a reality, taxes aren't going away anytime soon, so it's worth understanding the basics of how they work and how we can benefit from some of the rules.

Jerry Zhang

Programmer, YouTuber, and amateur musician. I like to write too!