A summer job is a classic rite of passage for teenagers. But teen jobs can be a source of aggravation for young workers and their parents who aren't prepared to deal with the potential taxes.
When it comes to income, the IRS generally wants its cut regardless of the earner's age. But some special tax rules apply to young workers, based not only on age, but also on amount of money earned and even the type of job.
First, the good news: The teen worker might not owe the IRS a dime.
A youngster who is a dependent of another taxpayer generally doesn't have to file an income tax return unless the youth makes more than the standard deduction amount for a single filer. For 2010 returns, that's $5,700.
If a young person doesn't expect to earn more than the threshold amount, he or she needs to note line 7 when filling out a W-4 at the summer workplace. That's where the teen might be able to claim exemption from federal income tax withholding.
In fact, novice workers should pay close attention to all employment paperwork. It could dramatically affect their tax responsibilities.
"Sometimes teens go out and work as technical employees, but are paid as contractors," says Sharon Lechter, a CPA in Paradise Valley, Ariz., and member of the President's Advisory Council on Financial Literacy. "So make sure the employer classifies you correctly."
Pushing the worker categorization boundaries is appealing to some companies who then don't have to deal with various tax withholdings and potential employee benefit payments. And young workers looking to pocket as much cash as possible each payday might think such an arrangement advantageous, too.
But being a contractor poses new, and costly, tax concerns.
Contactor Tax Complications
If paid as a contractor, which means earnings are reported to the worker and the IRS on a Form 1099-MISC rather than a W-2, the youth is for tax purposes self-employed.
That designation means that even if the young worker doesn't earn enough to owe federal income taxes, he or she could owe Uncle Sam self-employment, or SE, taxes.
This is the 15.3 percent tax on earnings that is the self-employed equivalent to Social Security and Medicare payroll taxes withheld from employees' checks and usually noted as FICA on pay stubs. That tax is required when any self-employed worker's net earnings exceed $400.
"There is no special tax treatment for teenagers running their own business," says Carol Topp, a Cincinnati CPA who is also the founder of TeensAndTaxes.com. "If you make a profit of more than $400, you must pay self-employment."
The frustrating thing about self-employment taxes is that while the income tax earnings threshold usually is adjusted each year for inflation, the $400 SE trigger is firm. And that low level often poses tax problems for young entrepreneurs, even if they don't make enough to mandate they pay income tax on their earnings.
That was the case for one of Topp's daughters. "She offered piano lessons and didn't make enough to file a tax return, but owed $80 in self-employment," says Topp.
Special Rules for Some Teen Jobs
Some young business people, however, do get a bit of a break. There are special tax rules for typical teen jobs.
Individuals who provide babysitting and lawn mowing services are viewed by the IRS as household employees. In these cases, a household employee who is younger than 18 at any time during the tax year the work was performed is not subject to Social Security and Medicare taxes.
The same SE exemption also is allowed for newspaper carriers, distributors or vendors younger than 18.
The Family Business
Instead of starting a new enterprise, some youths opt to go into the family business. In addition to having the inside track with the boss, this work situation might provide some tax relief for the employing parents as well as the young worker.
"If you're to employ your own child, there could be no withholding at all," says Thomas J. Casey, a Certified Financial Planner with Casey, Thomas & Associates, in Shelton, Conn.
When a parent's business is unincorporated (that is, it's a sole proprietorship or a partnership), the hiring mom or dad doesn't have to withhold FICA taxes if the youth is younger than 18. Federal unemployment tax payments also aren't required for the child if he or she is under age 21.
However, says Casey, parents who are generous employers will have to withhold income taxes if they pay their teenager more than $5,700 this year.
Other Income Issues
Tax responsibilities also can be complicated when a youngster receives earned (work-related) and unearned (investment) income in the same tax year. When a youth receives investment income, that amount also must be added to the youngster's earned income in determining his or her federal filing requirements.
Generally, children age 18 or younger must file and pay taxes on their unearned income when it exceeds a certain amount. For 2010, the figure is $950; the IRS reviews the amount each fall and if warranted, adjusts it for inflation.
If a child operates his or her own business, the young entrepreneur must track expenses in order to determine the potentially taxable earnings. The work-related costs will be reported on and subtracted from gross earnings on Schedule C.
Even if the young worker's net isn't enough to require the filing of a 1040, completion of Schedule C will make it clear whether, depending on the teen job, a Schedule SE must be filed to pay self-employment taxes.
And sometimes it pays to file a return. If a child did have withholding taken out of pay but didn't make enough to owe taxes, the only way to get that money back is to submit a 1040.
Finally, young business people need to be mindful of their state's tax filing demands, as well as possible sales tax requirements if the enterprise involves retail sales.
The various tax issues that the youngest workers encounter certainly can take some of the thrill out of joining the workforce. But Topp recommends that young workers look at ways the tax system can work for them.
"It's frustrating for the kid and parents to owe taxes, but it's part of being a grownup and being a business owner," Topp says. "I tell them to plan for taxes when they set their prices."