Teenagers coming of age often find a part-time job over the holidays or during the summer that enables them to exert some control over their financial life. But the potential tax issues can be thorny if they or their parents don’t know what’s expected of them.
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.
2018 tax year standard deduction
The 2018 tax year standard deduction for single taxpayers jumped to $12,000 as a result of the new Tax Cuts and Jobs Act, up from $6,350 in 2017. A dependent youth can earn up to that much and not have to file a tax return.
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.
For instance, are they asked to fill out a Form W-4 or a Form W-9? If it’s the latter, then young workers don’t have a job – they are self-employed contractors.
“Contractors get no benefits, such as paid vacations or holidays,” says Judy O’Connor, a certified public accountant with O’Connor & Rodriguez, P.A., in Miami Shores, Florida. “However, the employer is required to properly classify workers as employees or contractors. It is not a ‘choice.’ The IRS has certain criteria that helps the employer determine if someone is an employee vs. a contractor.”
Contractor 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.
What are SE taxes?
This is the 15.3% 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.
The frustrating thing about self-employment taxes is that the $400 SE trigger is firm and not adjusted each year for inflation. 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.
There is one bright spot to being self-employed, says O’Connor. “If you are a contractor, you receive your contract pay and then can deduct any ordinary and necessary business expenses incurred,” she says. “You’re only taxed on your net earnings.”
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.
What are the SE exemptions?
Individuals who provide baby-sitting 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 for employees younger than 18 is also allowed for:
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 CFP professional with Dean, Casey Financial Management in North Haven, Connecticut.
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 the filing trigger amount.
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 teen’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.
Young investors’ 2018 filing trigger
When a youngster’s investment income exceeds a certain amount, the youth usually must file a tax return reporting those earnings. For 2018, filing is required on unearned income of more than $2,100.
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 Form 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 having some spending money may compensate them for the aggravation.