Teens and Summer Employment: Tax Breaks Can Save Precious Money

Summer is here and the economy continues to be on nearly everyone’s mind. Unemployment numbers are not pretty, especially for teens and students who used to rely on summer jobs to pick up some cash for school and savings. But for teens lucky enough to find a summer job, or for parents trying to think creatively about how they can translate their needs into summer work for their children, paying attention to some of the tax breaks for young people offered by the IRS can make a big difference next April, and even possibly inspire some new ideas about summer jobs that might be advantageous to both employee and employer.

The Family Business: Hiring Your Teen as an Employee

Family businesses enjoy perhaps the most advantageous tax break available. For parents who have husband-and-wife partnerships or sole proprietorships, hiring their child can be a financial boon for everyone in the family. As long as the child is under 18, any income paid to them will not be subject to Social Security or Medicare deductions, both for the parent (employer) and the child (employee). Furthermore, the child won’t owe income tax on all income up to the standard deduction ($12,000), while the parent can still take a deduction on their payment of wages to the child. The child will not owe federal unemployment tax either. Of course, the IRS will be watching these work relationships closely, so parents should be careful not to overpay the child for the work he or she is doing. Parents can back up the employment with evidence of comparable pay rates in that particular industry. This is a great way to enjoy significant tax benefits while giving the kids a job and helping out the family business.

Considering Home Projects and Other Tax Pointers

Of course, not everyone has a family business, but there are still some interesting aspects of tax law relating to jobs for young people that might prove fruitful for parents and their kids this summer. For instance, suppose a parent has been thinking about having a new patio installed in their backyard. Rather than paying an expensive contractor to do the work, they could consider employing their able-bodied teenager in a variation of the “do-it-yourself” project. As long as the kid is under 21, they won’t owe any Social Security, Medicare, or unemployment taxes on the money they earn and, as with the family business, they won’t owe income taxes if they make below the standard deduction of $12,000.

On the subject of the standard deduction, if the summer worker does indeed expect to earn less than $12,000 over the course of the summer, then there is no reason to have income tax withheld from their paycheck. Why let Uncle Sam hang on to the money for a year before giving it back? Claiming an exemption from withholding of income tax is easy; it simply requires opting out when the employee fills out their W-4 form, usually on the first day of work. On the other hand, some people like having that extra bonus come in on their tax return, even if it means each paycheck is smaller, so the choice is up to the individual. Of course, summer workers should be careful if there is a chance they might make more than the threshold amount, because then they will end up owing money at the end of the year when filing their taxes.

On a related note, teens should be aware of their tax status – employee or independent contractor. Even if an employer has hired them for the summer and refers to them as an employee, this doesn’t necessarily mean they are considered an “employee” for tax purposes. The most important difference here is that employees have Social Security and Medicare taxes automatically taken out of their paychecks, while independent contractors do not. But being an independent contractor does not mean the worker is exempt from those taxes – they will still need to pay the taxes (assuming they have made over the threshold amount of $400), typically in quarterly installments known as “estimated taxes.” Quarterly payments of these “estimated taxes” may not be required for summer workers, however, as long as the worker estimates he or she will owe less than $1,000 in combined income, Social Security, and Medicare taxes for the tax year. The IRS offers a helpful guide to estimated taxes on its website.

Anyone working as an independent contractor might also consider keeping track of “business expenses,” such as miles driven to work in his or her personal vehicle, which can be deducted if the taxpayer chooses to use Schedule C on their return rather than take the standard deduction. Most teenagers and other summer workers, however, are likely to take the standard deduction because of its simplicity and the fact that summer jobs are unlikely to necessitate the kinds of deductions that will make using Schedule C worth it. But this is at least an option to keep in mind in case the job, for example, requires the worker to drive lots of miles in his or her own car. For additional information on itemizing versus taking the standard deduction, see the IRS website on this topic.

Never Too Early to Start Saving for Retirement!

Retirement is probably the last thing on the mind of a teenager looking for a summer job, but individual retirement accounts (IRAs) are a great way for kids to learn about the importance of savings. IRAs can provide excellent tax benefits as well, even for summer workers. For traditional IRAs, all contributions are tax-deductible, while withdrawals later in life are taxed. Meanwhile, Roth IRAs work in the opposite way, allowing no deduction for contributions but not taxing the eventual withdrawals. While most people typically consult with a tax advisor before settling on which type of IRA is better for them, young workers are generally better off with a Roth IRA because they are often in such a low tax bracket, current deductions would not make a great difference in the amount of tax owed anyway.

No matter what their individual situation is, all summer workers should be aware of their tax status and pay close attention to the amount of money they expect to make over the course of the summer. To avoid surprises when filing taxes next year, make sure that the proper amounts are being withheld from each paycheck. Most of all, consider work relationships that could be advantageous for all parties, like kids performing work in the home for their parents. In today’s economy, every little bit of tax relief can make a difference, for both kids and their parents.

Case Studies: Teens and Summer Employment

Case Study 1: Family Business Advantage

Sarah’s parents run a small landscaping business. During the summer, they hired 17-year-old Sarah to assist with various tasks. By employing their daughter, Sarah’s parents enjoyed significant tax benefits. Since Sarah was under 18, her income was not subject to Social Security or Medicare deductions. Additionally, Sarah’s earnings up to the standard deduction ($12,000) were tax-free, reducing their overall tax liability. The arrangement proved advantageous for both Sarah’s parents and their family business.

Case Study 2: Home Projects and Tax Savings

Michael, a 19-year-old college student, sought ways to earn money during the summer. His parents considered installing a new patio in their backyard and decided to hire Michael for the job. As long as Michael earned below the standard deduction, he wouldn’t owe any Social Security, Medicare, or income taxes on his income. By employing their son for the project, Michael’s parents saved on payroll taxes, and he earned tax-free income, making it a win-win situation.

Case Study 3: Retirement Savings and Roth IRA

At 18 years old, Emily landed a summer job. Although retirement seemed far off, her parents encouraged her to open a Roth IRA to learn about savings and tax benefits. As a teenager in a low tax bracket, Emily’s contributions to the Roth IRA were more beneficial than the deductions offered by traditional IRAs. By choosing a Roth IRA, she set herself up for tax-free withdrawals in the future, making it a wise long-term investment.