After years of paying for camps or other expensive vacation diversions, it can feel like a real parental achievement when your kids are finally old enough to land summer jobs. Then comes the dreaded realization: They’re going to have to file tax returns.
Teen summer wages might seem small, but any earned income comes with the complications of grown-up salaries, regardless of whether they are paid as employees or just earn some extra cash mowing lawns. Additionally, as a family, you have to consider how to best make use of the funds and how a kid’s growing bank balance might impact the cost of college.
Most likely, it’s in a teen’s benefit to file a tax return — even if it’s not technically required. But this could get costly. Handing over your kid’s return to your tax professional could double the fee. “It’s still a tax return,” says Adam Markowitz, an enrolled agent and partner at Luminary Tax Advisors in Florida.
But others may give discounts if it’s a small amount in addition to other work. “Then I get peace of mind that it’s done right,” says AJ Campo, a CPA whose firm is based in New Jersey.
If you use tax software, you’ll likely have to pay separately for each return, depending on the level of service you choose. The good news? You can file a simple return for free with the IRS’s free file system. It’s so easy your teen can probably handle it themselves.
You can’t avoid taxes even for small amounts
A teen’s tax burden for summer jobs depends on how they earned their money and where they live. Unearned income is a different beast. The income from investments above the kiddie tax thresholds — generally $1,250, but with lots of complexity — would trigger separate rules.
Earned income is what your child makes from actual work. Basically, any amount can be fair game. “Some states tax from dollar one,” says Markowitz, and, for the most part, if you want to file a state return, you have to file a federal return.
If your child earns off-the-books cash income from, say, babysitting, the official federal threshold for filing self-employment income is $400 – but you actually should file for any amount earned, Markowitz cautions. This may sound like an unnecessary burden, but it might actually benefit the child down the road. (Parents who pay babysitters and other household help are governed by different tax rules, and should check on their own responsibilities.) If that income is on the record as earned income, teens can contribute that amount to a Roth IRA. More on that in a minute.
If your child got a 1099 for freelance income, they’ll definitely want to file, because the government may flag them for penalties automatically if they see that no return is filed. “This is just a computer saying there’s a 1099 and no return,” says Markowitz. If your child earned $1,000, the tax would be $153 — 15.3% self-employment tax that goes toward Social Security and Medicare — and the penalties could be around $80. Plus, this comes with a scary letter from the IRS that may cause the parents to seek a professional consultation, which costs by the minute.
“Anytime anyone sees a letter from the IRS, they flip out. But it’s going to be $300 to even talk about it, because it can be a very arduous process to sort these things out,” says Markowitz.
Regular work requires regular taxes
If your child earned W-2 income, then the federal threshold becomes the standard deduction, which is $13,850 for singles in 2023.
Sample pay stub of teen in New York.
A teen who knows they won’t earn over the standard deduction and doesn’t want to file can write “exempt” on their W-4 form and not have federal income taxes withheld from their paycheck. But that won’t stop that “aha” moment kids get when they look at their paychecks and see all the things taken out of it – because there still will be line items for Social Security, Medicare and possibly state taxes.
If they earned less than the standard deduction but had taxes withheld, they should definitely file a return so they can get a refund. With this level of earnings, as with self-employed income, they may also be better off filing because it allows them to contribute that amount to a Roth.
If your teen is earning more than $13,850, then congratulations, you’ve unlocked another big parental achievement. They’ll need to file a tax return, of course, and maybe even pay some tax rather than have it all refunded.
One important tip from Markowitz and Campo: When your child (or, let’s face reality, you) is filling out their return, make sure they click the box or answer yes in an electronic filing program when it asks if somebody else claims them as a dependent. Otherwise, you will be blocked from claiming them, which is worth $2,000 per child under 17, and $500 per child 17 and older. Plus, you’ll have to go through the hassle and expense of correcting the mistake.
“The IRS will reject your tax return, and then you’ll have aggravation,” says Markowitz.
How to spend the money
What to do with summer earnings can turn into a major family discussion, and a big teaching moment. Do you let them spend it all on what they want? A portion of it? There’s a lot that can go into it. But one tax-smart move is to take that earned income and open a Roth IRA for minors at a brokerage house like Fidelity or Schwab. These operate like adult Roths, just owned by a parent until the child turns 18, or 21 in some states.
Tax-free growth in perpetuity is, of course, the major advantage of a Roth. A teen with a 50-year-time horizon could have a nice nest egg down the road even with just small contributions. The other less-considered benefit: Retirement accounts don’t count toward most financial-aid calculations. If your child has $1,500 in a checking account (hopefully a high-yield account), colleges typically consider half of that fair game to put toward tuition. But if it’s in a Roth, it doesn’t go on the form.
If they need access to that money to help pay for school, they can take out contributions at any point. Any growth, though, would generally be taxed as income until they’re 59 ½ and subject to a 10% penalty, unless it’s for one of the named exclusions, like buying a house.
Another pro tip: To maximize the earned income for Roth contributions (which can be up to $6,500 in 2023), teens might want to claim all tips along with documented income. “With cash tips, people usually do not want to report them, but if the goal is to put money into retirement, you’d want to,” Markowitz says.
More from Beth Pinsker
This story originally appeared on Marketwatch
