Along with establishing a good work ethic and building time and financial management skills, a summer job also means learning about the obligatory duty of paying taxes. To help navigate the tax process, we have put together a list of six tax tips to be aware of when a child prepares for a summer job. We hope these tips will help you and your child plan ahead and know what to expect as they begin their summer job.
1. Understand the Rules for Claiming Dependents
You may be wondering, since your child has a summer job, if you will still be able to claim him or her as a dependent on your own return. The answer is, "Yes." A child under the age of 19 (or under the age of 24 and a full-time student) can make any amount of income and still be claimed as a dependent as long as you are still providing more than half their support. This includes food, shelter, clothing, entertainment, school expenses, vehicle expenses, etc. As “independent” as your child may feel now that they are taking on some responsibilities of their own, when you add up all of the expenses, it may be surprising to see how “dependent” working children still are on the support of their wonderful parents!
2. Filling Out Form W-4: Determine How Much To Withhold
Before your child begins a summer job, he or she will be required to fill out a federal and state Form W-4 to instruct the employer how much to withhold for federal and state income taxes. To determine how much, if any, should be withheld, it is important to note the thresholds of when your child will need to file an income tax return. Estimate how much they will earn this summer based on their wages and expected hours to be worked. Regardless of amounts withheld for income taxes, Social Security and Medicare tax will be withheld at the regular 6.2 and 1.45 percent rate and is never available for refund.
3. If No Taxes are Withheld, Set Money Aside to Be Prepared for Tax Time
Your child may have a summer job when the employer does not take your child on as an official employee, but, rather, as an independent contractor for their temporary summer work. In this instance, your child's paycheck will not include any deductions for Social Security and Medicare tax, nor will there be any withholdings for federal or state income tax. If $600 or more is earned from this employer, your child should receive a 1099-MISC at the end of the year. Most likely the income will be shown as "Non-employee Compensation" in box 7 of the 1099-MISC. This is treated as self-employment income and is subject to self-employment taxes. In this case, your child must file a return if earnings were at least $400. Be aware that because the employer did not withhold and pay any taxes on behalf of your child, taxes may be owed when tax returns are filed the following spring. It will be a good idea for your child to set aside money from each pay check so that he or she can pay the tax when the returns are filed.
4. Know the Tax Implications of Employing your Child
Many of you may be exploring the idea of hiring your child for the summer. Giving your child a summer job may provide an opportunity for tax savings for you as the employer as well as for your child. There are tax benefits of having your child as an employee if your trade or business is a sole proprietorship or partnership in which you and/or your spouse are the sole owners or partners.
Wages paid to your child who is under the age of 18 are not subject to Social Security and Medicare taxes, or Federal Unemployment Tax (FUTA). Wages paid to your child who is 18 years or older, but under 21, are not subject to FUTA. Your child's wages are a deductible business expense to your company, as long as your child is treated as a regular employee, wages are paid in dollars, and a W-2 is filed.
According to "Tax Dos and Don'ts for Hiring Your Child", on wsj.com, Laura Saunders reports that a Tax Court judge in Washington disallowed a business owner from deducting $15,000 in wages to her three children ages 15, 11, and 8 who helped their mom with tasks such as stuffing envelopes.
The business owner's method of payment was regularly expected parenting expenses such as food, lodging and tutoring services. In other words, you cannot use pizza as a form of payment to your employee-child and use the value as a business deduction for wages. The IRS recommends you pay your employee-child via paycheck and have him or her deposit it into his or her own bank account. This will verify that your child received the funds.
5. Understand How Taxes Work with an Out-Of-State Summer Job
If you reside in Illinois and your dependent child gets a summer job out-of-state, your child is considered an Illinois resident and will need to file an Illinois return based on Tip #2 above. If the job is in Iowa, Kentucky, Michigan, or Wisconsin, a reciprocity agreement exists with Illinois. This means the out-of-state employer will withhold and pay Illinois taxes and no taxes should be paid to that employer’s state. In most other states, taxes will be withheld and paid to the state of employment. In those cases, an Illinois return and a non-resident return for the state of employment will need to be filed. The good news is, any taxes paid in the other state will be a credit on the Illinois return. Tax rules differ from state to state so it is a good idea to do your homework and understand the income tax filing requirements for the employer's state.
6. Understand Roth IRA Eligibility and Benefits
Something else to think about if your child gets a summer job is that he or she will be eligible to start making Roth IRA contributions. While retirement may seem like eons away for your newly working teen, the power of compounding is amazing. In addition, the contributions can be withdrawn tax-free and penalty-free at any age and the earlier they begin contributing, the greater the earnings potential.
As you can see, there is a lot to keep-in-mind as your child—or the child of one of your clients—begins exploring summer job opportunities since the tax implications can be complex.
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