With summertime behind us, many parents have recruited the help of their children at their companies during the child’s time off from school. Summer jobs not only keep the child busy and productive, they also teach them the responsibility of working and paying taxes. While summer jobs can be an enriching experience, the extra income could potentially create an unfavorable tax consequence for the child and the parent. Having a good understanding of withholding taxes can ensure that there are no surprises come tax time.
Generally speaking, a child that can be claimed as a dependent does not have to file a separate tax return. However, there are exceptions to that rule:
- A tax return will have to be filed if a child’s earned income is greater than the standard deduction. The standard deduction has increased to $6,350 for the 2017 tax year.
- A dependent will have to file a return if their unearned income (interest, dividends, and investment proceeds) exceeds the greater of $1,050 or $350 plus the child’s earned income.
- If a dependent earns less than these income thresholds mentioned above, then no federal or state taxes need to be withheld from their paycheck as they will not have a tax liability.
There will also be tax consequences for a child that begins his own business. The IRS does not give special treatment to teenagers in regards to self-employment taxes. A child will have to pay self-employment taxes if they earn a profit (gross income minus expenses) greater than $400. They could potentially be able to opt out of federal and state withholding taxes due to earning less than the standard deduction, but would still be required to pay self-employment taxes. Planning ahead ensures that they set aside the amount due from their gross profit to pay the self-employment taxes that they will owe at tax time. Self-employment taxes are 15.3% of a business owner’s net income. Exceptions to this rule also exist:
- A child will not be subject to self-employment taxes if he or she is viewed as a “household employee.”
- These employees include babysitters, lawn mowers, newspaper carriers, distributors, and vendors under the age of 18.
For parents who own their own business, employing your child can be a smart tax decision. Sometimes children qualify as exempt from taxes when working for their parents. If your company is a partnership or sole-proprietorship, you should consider hiring your children to work for you. FICA taxes, which include Social Security and Medicare taxes, do not have to be withheld from a dependent’s paycheck if they are under the age of 18. Federal unemployment taxes also do not have to be withheld from a dependent’s wages if they are under the age of 21. As a business owner, you get the benefit of the payroll expense without additional payroll taxes, and your child gets the most out of their paycheck. If the child’s earnings are anticipated to exceed the standard deduction listed above, federal and state withholding may be needed to cover any tax liability that will arise when the child files his return.
Employing your children or encouraging them to begin their own business can be beneficial in many ways. The key to avoiding a tax mishap is doing research, talking to a tax professional, and planning ahead. Earning the most cash possible through a summer job can help make your child’s time off from school extremely rewarding and having more help around your office is just an added benefit.