Summer Job Issues for Students and Parents
Summer is a great time for students to make some extra money so many students are out hunting for summer jobs. You might not think so, but there are some important tax considerations for both the students and their parents.
First of all is the question, will the student make enough money during the year that he or she will have a tax liability?
In general, if your student can be claimed as a dependent, they won't have to file a tax return if their unearned income is $350 or less and their total income won't exceed $6,200. But if their investment income is more than $350 and total income tops $1,000, a return will be required.
There is also potential tax on any self-employment income the student may have regardless of the limits just mentioned, as discussed below.
When a job is first started, Form W-4, Employee's Withholding Allowance Certificate is typically requested by the employer. This form is used by the employer to determine the amount of tax to withhold from the paycheck.
If the student expects to have a tax liability, make sure the W-4 is completed so that adequate tax is withheld to cover the expected amount.
This is especially important if the student has multiple summer jobs. If this is the case, the withholding from all jobs needs to be coordinated to make sure enough is withheld.
A nice thing about predetermining that your student may not have a tax liability for the year is that the student can avoid withholding from their paychecks. They would qualify for exemption from withholding if they did not owe any tax last year and do not expect to owe any this year.
If the student qualifies for this exception, you notify the employer of this simply by writing "EXEMPT" on line 7 of Form W-4, and no income taxes will be withheld from your pay.
Be careful, though, because if taxes end up being owed, the student (or maybe you, mom and dad) will have to cough it up later when tax returns are filed.
Earlier I mentioned the possibility of the student having self-employment income. This is because many students may not have a regular paying job, but rather do odd jobs over the summer such as lawn care and babysitting.
This type of income is considered self-employment income since there is no "employer". Earnings from self-employment are subject to income tax just like any other job.
However, even if not enough money is earned by the student to owe any income tax as discussed earlier, tax could still be owed. This is because if the student earns $400 or more from self-employment, they have to pay what is called self-employment tax.
Self-employment tax is the equivalent of the social security and medicare tax (FICA) that employers are required to withhold from all employees pay regardless of the level of income. Thus, if there is self-employment income, a tax return will likely be required for the student even the income tax doesn't apply.
Finally, how about some tax planning ideas for parents and students?
Did you know that hiring your children can lower your tax bill as well?
No FICA tax is due if sole proprietors or husband-wife partnerships hire their kids who are under 18. This is also true if they work for a parent's one-person LLC that is considered disregarded for tax purposes.
Nor is federal unemployment tax owed on their wages until the kids hit 21 years of age.
Compensation to children also is deductible by the parent's business, so they reduce the parents' income and self-employment tax liabilities.
And lastly, if your child (or grandchild for that matter) will be working this summer, you may want to consider contributing to a Roth IRA this year for the child. You can contribute up to $5,500 (limited to the amount of earned income the child actually makes).
Why do this? Well, you can help your child get started on building a nice retirement nest egg for which they will be grateful.
For example, one $5,500 contribution made at age 16 to a Roth that earns 6.5% per year will be worth almost $132,000 by age 65 and even better, just over $182,000 by age 70.
Just think about what could be there if contributions are made each year that the child works!
A reminder, though, any contributions made are considered gifts to your child, so count toward the $14,000 annual gift tax exclusion you are allowed to make without filing a gift tax return ($28,000 if your spouse participates).
