Summer jobs and tax questions
And so another summer begins ... school is out, and many teens join the ritual of working a seasonal job. While earning a few extra bucks helps build savings for college or provides a feeling of independence, it also brings a lesson in taxes.
Working children and their parents need to have a handle on the tax implications of a child's summer job earnings. It's a good idea to know how to report these earnings and to have a plan before the W-2 arrives next January.
The first thing to know is how much you can earn before you have to file a tax return. In 2015, the earned income threshold is $6,300. It's important to note that this is for income from working, and a different amount applies to income from investments (dividends, interest, etc.).
What if the income is less than $6,300? Even though you're not required to file a tax return, there's usually a good reason to do so anyway: It's called a tax refund. If your employer withheld federal and state taxes from your pay, you'll have to file a return to claim a refund.
Alternatively, if you're certain you won't earn over the $6,300 limit, you could claim an exemption from tax withholding by filing a Form W-4. You can do that if you didn't owe any tax in the previous year. But even if you do this, your employer will still withhold FICA, or Social Security, taxes from your pay.
Some employers hire summer workers as freelancers or independent contractors. If you're paid as a freelancer, your employer won't withhold any taxes. You may think this is great because it saves you the hassle of filing a tax return to get a refund, but not so fast. When you're paid as a freelancer, the income must be reported as being from self-employment. This means you'll have to file a tax return and pay the 15.3 percent self-employment tax on income that exceeds just $400.
When you're paid as an employee, you pay half of this amount because your employer pays the other half. Most employers are required to issue a 1099-MISC for payments of $600 or more made to the workers they paid as contractors, so you're really unable to avoid this requirement.
One of the great things about being young and earning money from a seasonal job is that you're allowed to open one of the best long-term retirement savings accounts available -- the Roth IRA. As long as you have income from earnings, you're eligible to contribute to a Roth IRA.
Because there's no deduction for Roth IRA contributions (which wouldn't really benefit most young seasonal workers) and all future growth can be tax-free in retirement (which should be a huge benefit given the long time horizon), this is an ideal savings strategy. In 2015, the Roth IRA contribution limit is $5,500.
Here's an example of how powerful this savings opportunity can be. Suppose a 15-year-old earned $3,500 this summer and saved $2,500 of that in a Roth IRA. Assume she invested in a great stock or stock fund, and earned an annualized 10 percent return. At age 65, that $2,500 could grow to over $360,000. And all of the withdrawals from the Roth IRA would be tax-free in retirement.
There's no minimum age to set up a Roth IRA, and many financial firms will accept applications for minors. Some firms, such as Fidelity, may balk at opening accounts for minors, but others such as Schwab welcome them.
