You were there for your child when he lost his first tooth. You were there for them when they graduated from kindergarten. Now they are ready to enter the job market and you will be there when they receive their first salary. A summer job is a rite of passage for many teens to earn money and take their first step in learning financial responsibility. They will have questions about taxes and why Uncle Sam took part of their income. Here’s what you need to know to guide them.
If your teen is in a mid-paying job, they’ll fill out a W-4. Remember that not claiming any benefits means you want the most tax taken from your salary. This is usually the safest strategy, but it can delay hard-earned money until they file their first tax return. Claiming too many allowances can lead to underdeduction and a surprise tax bill in April.
The standard deduction for singles has increased from $12,550 in 2021 to $12,950 in 2022. So your child can now earn up to $12,950 in their summer job and pay no income tax.
Your teen may earn even more than the standard deduction. Let’s say your teenager contributes $6,000 of his earned income to a traditional IRA. In this case, they could earn $18,950 tax-free by combining the standard deduction and the maximum allowable deductible contribution to an IRA, which is $6,000 for 2022. A great way to teach about saving is to have your child invest a portion of their earnings in a Roth IRA. A Roth IRA offers tax-free gains and distributions. The only downside is that contributions to a Roth IRA are not tax deductible.
If you are self-employed, consider hiring your children to work for you. Rather than supporting your children with your after-tax dollars, you can hire them into your business and pay them with tax-deductible dollars. Of course, their employment must be legitimate and their remuneration must be adapted to the hours and the job worked. Giving your child a reasonable salary reduces your self-employment earnings and your taxes.
Example: Let’s say you own an unincorporated business and you are in the 24% tax bracket. If you hire and pay your child $16,000 a year, you can reduce your income by $16,000. This will save you $3,840 in income tax (24% of $16,000). After the standard deduction, your child will have taxable income of $3,050 ($16,000 – $12,950) and the tax is $305 (10% of $3,050).
Suppose your business is unincorporated and you pay a salary to a child under the age of 18. In this sense, the salary will not be subject to FICA (Social Security and Medicare taxes) because the services rendered by a child under the age of 18 while employed by a parent are exempt from taxes. FICA. As a result, your child doesn’t have to pay FICA taxes, and your business won’t have to pay half of it either.
A similar exemption applies to FUTA, which exempts income paid to a child under age 21 from federal unemployment tax. The FICA and FUTA exemptions only apply if a child is employed solely by their parent or by a partnership consisting solely of their parents. These exemptions do not apply to incorporated businesses or a partnership that includes non-related partners. Hiring your child instead of someone else will not incur additional business costs.
Lauren Garabedian Ruff, CPA, is Chief Operating Officer and Business Advisor at The Garabedian Group, Inc. in Fresno, California. She specializes in family business support, succession planning and taxation. Lauren has been practicing for ten years. To contact Lauren Garabedian Ruff, call (559) 472-7370 or visit www.thegarabediangroup.cpa.