School is out for the summer. For many high school and college aged young Americans, that means the start of a summer job. The U.S. Bureau of Labor Statistics reported that 18.6 million youth between the ages of 16 and 24 were employed last July, and we can expect close to the same number on payrolls this year.
In addition to providing some extra cash, summer jobs are a great opportunity for young Americans to learn about income taxes, and also to increase their personal financial literacy by understanding that taxes are not just automatic and don't always result in a refund. As a parent and a tax professional, I know firsthand the importance of preparing children for financial responsibilities, and now is an excellent time to start that conversation and develop skills that will pay benefits over the course of a lifetime. With that, here are five things every parent needs to know before talking to their children about the tax implications of their summer job:
- Tax rules for claiming working dependents -- Tax rules for a dependent child are different than the rules for any other type of dependent. A dependent child can have any amount of income and still be claimed as a dependent, as long as he or she does not provide more than half their own support. This includes gifts, entertainment, food, shelter, clothing, purchasing a vehicle, maintaining a vehicle, other forms of transportation and school expenses. Any other type of dependent who receives more than3,800 income in 2012 cannot be claimed as a dependent, even if a legal guardian provides more than half of their support;
- W-4 Tax Forms - All employees will have taxes directly deducted from their paychecks. Independent contractors generally receive the full amount of their income when they are paid with no deductions, and they are then responsible for paying income and payroll taxes on their own. This can come as a surprise to many young adults come tax time. Employees are required to fill out a W-4 tax form before beginning their employment to let their employer know how much of their income to withhold for taxes. A good rule of thumb for young adults working part-time in the summer is to claim zero exemptions when completing their Form W-4 to ensure they have enough taxes withheld come tax time;
- When to Start Filing a Tax Return -- If individuals, including young adults, have at least400 in income, they may be required to file an income tax return. Young Americans who can be claimed as a dependent on another taxpayer's return (usually their parent's or legal guardian's) cannot claim their own exemption. This is true even if the other taxpayer chooses not to claim the individual as a dependent;
- Tips -- Employees in many summer jobs, such as waiting tables or cleaning pools, earn tips as a part of their compensation. All tips are considered taxable income and are therefore subject to income tax. Any income earned from odd jobs, including babysitting and mowing lawns, is also subject to income tax. Should an individual have net earnings of400 or more from self-employment in a single calendar year, they will be required to file a tax return and may have to pay self-employment tax; and,
- Claiming Child Tax Credits -- Working youth under the age of 17 are still eligible dependents for the Child Tax Credits. If you can claim a working 16 year old as a dependent, you can usually claim the Child Tax Credits, which can be worth up to1,000 per eligible dependent.
While there is little impact on the parent's tax return when a dependent child works, it can be difficult for a teenager to think about how a summer job can affect their tax return the following year. Understanding the tax implications now can help young taxpayers make smart decisions to lower their tax expenses and possibly increase next year's income tax refund. Those who tend to get the largest tax refunds are those who plan their tax strategy throughout the year, not just at tax time.