In The Good Old Summertime!
School is out and many students have hit the pavement looking for summer work or perhaps are working for businesses owned by their parents.
Here are a few pointers to benefit your student, and that might also help you reduce your own tax burden.
Many students only work in the summer and consequently may not make enough money during the year to require them to file a tax return. Nonetheless, all too often, federal and/or state income taxes are withheld from their pay, forcing them to have to file a tax return if they want to get it back in their pockets.
Did you know there is a way around that? If the student owed no income tax for last year and doesn't "expect" to owe any for the current year, withholding can be completely avoided, which may save the filing of a tax return later. This is done simply by writing the word "Exempt" on the Form W-4 required to be completed by the student for the employer.
An exception to this rule are children who can be claimed as dependents on another's return and who will have more than $350 in investment income and more than $1,050 in total income. Those kids are still subject to withholding.
Further, the exemption is for income tax withholding only. It does not stop the withholding of the student's share of Social Security and Medicare taxes.
Here's another "did you know"…did you know that hiring your children to work in your business could lower your payroll tax bill? It's true!
If you are a sole proprietor, a single-member LLC that is disregarded for tax purposes, or a husband-wife partnership, you can hire your kids to work for you, and if they are under age 18, no Social Security or Medicare tax is due for them. That's a 15.3% tax savings when you consider both the employer and employee share of the FICA tax.
Additionally, you do not have to pay unemployment taxes on them until they reach the ripe old age of 21.
To further sweeten the deal, what your children earn from working for you is deductible by your business, so such pay also reduces your own income tax and self-employment tax liabilities.
Finally, here's an idea to further financially help a child or grandchild who will be working this summer. Consider making a contribution to a Roth IRA this year for the child. You can contribute up to $5,500 to a Roth IRA in a child or grandchild's name, limited to the amount of earned income the child actually makes, as is the case for anyone.
By making this contribution, which by the way counts toward the $14,000 annual gift tax exclusion you have, you can help the child get started on building a nice retirement foundation.
And there are key tax benefits associated with Roth IRAs, such as the ability to make tax-free withdrawals (including withdrawals of earnings) after age 59½ or to pull out up to $10,000 in earnings tax-free at anytime you want to buy a first home (contributions can be pulled out tax-free at any time as well).
To show the power of this, consider one $5,500 contribution made at age 16 to a Roth that earns 6.5% per year. That single contribution will be worth almost $132,000 by age 65 and over $182,000 by age 70.
Just think about what would happen if contributions are made each year of the child's working life!
