By Jason Alderman
High school and college students hoping to find temporary jobs may be in for a tough time this summer – once again – as they compete with older, ask more experienced workers in a still-struggling economy. But if your kid is fortunate enough to find work, sick there are a few things he or she – and you – should know about the economic and tax ramifications of temporary employment:
Payroll deductions. If this is their first job, warn your kids about common payroll deductions that can take a big bite out of take-home pay. Common culprits include state and federal income taxes, Social Security and Medicare (FICA), health and unemployment insurance, uniforms and union dues.
When starting a new job your child will be asked to fill out IRS Form W-4, the Employee’s Withholding Allowance Certificate. Employers use this form to determine how much income tax should be withheld from your paycheck. The form’s instructions help determine how many personal allowances can be claimed.
Note: If you claim your children as dependents and they earn less than $5,950 during 2012, they probably won’t owe any income tax for the year. If so, they can request that employers not withhold income taxes by claiming an “exemption from withholding” on Line 7 of the W-4. However, if you notice on their year-end W-2 form that the employer did indeed withhold federal and state income taxes, your child must file a tax return in order to get a refund.
Self-employed status. Many teens start their working careers by being self-employed, doing part-time jobs like babysitting, yard work or housekeeping. It’s important to know that this income is also subject to income tax.
If their self-employment net earnings exceed $400 in 2012, your kids also must pay self-employment tax, even if they owe no income tax. This tax is similar to the Social Security and Medicare taxes that get withheld from regular wages. Self-employment tax is assessed at 13.3 percent of net self-employment income reported.
The IRS provides a handy guide called “Taxable Income for Students” guide that explains what types of income are and are not taxable (www.irs.gov). For example, tips, bank account interest and certain scholarship-paid expenses (such as room and board) must be reported as taxable income.
IRA contributions. Retirement is probably the last thing on your teenager’s mind, but you should know that they are allowed to open and contribute earned income up to $5,000 to an IRA each year. If you or the grandparents want to make a down payment on your kid’s future, consider funding an IRA. For teens it usually makes sense to open a Roth IRA as opposed to a traditional IRA. Here’s why:
With a Roth, you pay tax on the contributions that year – and kids are usually in the lowest tax bracket. Then, contributions and investment earnings grow tax-free forever. With a traditional IRA, you make pretax contributions but pay income tax on withdrawals at retirement – usually at a much higher tax rate.
If someone opened a Roth IRA at age 16 and contributed only $1,000 a year, the account could be worth over $300,000 by age 60. Sit down with your kid and play around with the Roth IRA Calculator at www.dinkytown.net – it’s a great way to teach the importance of compound earnings.
Jason Alderman directs Visa’s financial education programs. To Follow Jason Alderman on Twitter: www.twitter.com/PracticalMoney.