Summer is coming, bringing temporary jobs for young Americans — and the first step with U.S. taxes.
Many summer workers won’t owe income tax because they don’t earn enough, even in a hot job market. But they will often owe Social Security and Medicare taxes, and perhaps state and local taxes as well.
These early paychecks are a great introduction to one of the certainties in life. Just like earnings later, summer paychecks come with tax complications and pitfalls. They even offer what professionals call “planning opportunities,” which are strategies to legally lower taxes now or later.
Of course, young workers may not find these problems – that’s where parents, grandparents and guardians come in. For summer workers and their families, here are important tax questions and answers.
What taxes can summer workers owe?
The three most important are federal income taxes, federal payroll taxes for Social Security and Medicare, and state income taxes. Their details vary depending on whether the worker is a salaried employee or a self-employed person with a contract or gig.
For 2022, there is no federal income tax on wages (for employees) or net income (for self-employed workers) up to $12,950 earned by single people. Above that, the income tax rate will be at 10%.
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Federal payroll taxes for Social Security and Medicare are charged on disability, retirement, and healthcare benefits you can claim later. For employees, they apply from the first salary dollar, and the rate is 15.3% (12.4% for Social Security and 2.9% for Medicare), even though employees only pay that half percent. The employer pays the other half.
Self-employed taxpayers typically owe the full 15.3% payroll tax on their net income, although they can deduct half of it.
Mark Luscombe, chief tax analyst at Wolters Kluwer Tax & Accounting, said: “Since payroll taxes are flat taxes, people on lower incomes typically owe much more in payroll taxes than income taxes.
State and local income taxes vary widely, so check the taxes in your area.
Why does summer pay have so many deductions?
Young workers often ask this. The answer is that employers often have to send a portion of each employee’s paycheck to the tax office so filers don’t have large bills at tax time. These amounts are called withholding, and the company will report the total for 2022 on the W-2 tax form, along with wages, for the employee in 2023. The IRS also takes the data.
If the company deducts as if summer workers would be working all year, the deductions may be too high. Workers have two options: fill out an IRS form W-4 to reduce withholding, or file a tax return next year to claim a refund.
My teen paycheck has no deductions. Why not?
The most likely reason is that the company considers him or her to be a freelance contract worker, contractor, or other unemployed employee working for hire, as described above. Instead of a W-2 form, such workers receive a 1099 tax form that reports gross wages to them and to the IRS.
Various tax rules for 1099 recipients, both for better and for worse. No taxes are withheld, and the employee can deduct expenses that the employee cannot. But as described above, Social Security and Medicare payroll taxes are higher.
Melissa Labant, an attorney and CPA with the accounting firm CLA who has two teenagers about to start summer jobs, urges workers to check in advance whether they will receive a W-2 or 1099 tax form. .
Are taxes different if a child works in a family business?
Often they — for the better. Children under the age of 18 who work in a non-corporate parent-owned business, such as a sole proprietorship or partnership with no outside partners, do not owe federal payroll taxes. That’s a tax break equal to 15.3% of their salary.
Even without the payroll tax exemption, family businesses can often deduct a child’s paycheck. The wider the gap between the parent and child’s top tax rate, the greater the benefit. For parents with the highest percentage of 32%, Uncle Sam typically receives about a third of the child’s expenses, while the child owes income tax at a low or zero rate.
Michael Tripp, a lead agent at Shared Economy Tax, a firm that provides tax and advisory services to more than 400 owners of short-term rental homes, explains how these breaks can combine with together.
He said his clients often hire their teenagers to clean up family rentals for an hourly wage that matches an annual salary of around $6,000. Parents/owners then get a tax deduction for the teen’s wages and don’t have to pay federal taxes on them. The total cost of hiring an outside contractor will likely be higher.
Because the kids don’t make a lot of money, they usually don’t owe income tax and don’t need to file a tax return. Often part or all of the payment is transferred to the custodial account the child claims as an adult.
“For a large family with several short-term rentals, the tax savings can be substantial,” Mr. Tripp said.
So can parents hire their children to do housework and clean the room?
Not too fast! Parents cannot make a deduction when the child is working for their business, and the tax preparer must be able to demonstrate to the IRS to satisfaction that the work was actually done.
Ms. Labant says her general rule is that children should only be hired to do work that parents would pay someone else — and that doesn’t include housekeeping. Mr. Tripp adds that the short-term rental owners he advises who rent their children often ask them to fill out checklists and time sheets.
What about tax-saving strategies?
Often the best strategy is to use summer pay to fund a Roth IRA savings account. For young earners, a Roth IRA can be a great deal because contributions are measured in after-tax dollars, even if the employee owes no tax on these earnings. Contributions can then be invested and grown tax-deferred for decades, and withdrawals in retirement can also be tax-free.
It’s just a free person, but there’s more to it: If a parent, grandparent or friend wants to save an investment, he or she can give the young worker a cash gift to fund to a Roth IRA and let her keep her earnings.
Another major advantage of a Roth IRA is that — unlike a traditional IRA — contributions can be withdrawn without penalty. Only withdrawals of account earnings are subject to restrictions and penalties.
So let’s say a worker contributes a total of $40,000 to a Roth IRA between the ages of 18 and 30. He can then withdraw up to $40,000 tax-free and free for any reason, like such as to help pay in advance.
The 2022 limit on Roth IRA contributions is $6,000 for most single applicants, and savers can’t put in more than earned (non-invested) income. So, if a student makes $4,000 as a summer employee, that’s usually how much she can contribute to a Roth IRA. The rules are more complicated for freelancers but still beneficial.
What about tax returns next year?
If summer workers are due for a refund, owe payroll taxes on contract employment, or want records showing enough income to fund a Roth IRA — among many other things — they should file. .
Parents are not allowed to simplify the process by including this income in their own income, even if it is earned by a dependent child. If the return is due, the child must file it.
But many people won’t need to file if they’re single, their paycheck has no deductions and is less than $12,950, and they have no other income, credit, or deductions.
Of course, parents should explain all of this, as those who work this summer will have full-time jobs tomorrow. It is also possible to start learning now.
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