As summer approaches, many teenagers are lining up a summer job or looking forward to spending their extra time working in their parents’ business. For teenagers and college students, this may be the first time they face the realities of income tax. In this article, we cover a few of the myriad tax considerations to be mindful of if your child works for you or starts a summer job while still classified as your dependent.
If your high school or college student gets a job working at the local fast food restaurant, they’ll be asked to complete employee-related paperwork such as a Form W-4 and a state equivalent (in Louisiana, this is an L-4) to set any income tax to be withheld from their paychecks. While this may seem fairly mundane, carefully completing these forms can save some time and money later depending on how much they project to earn.
Currently, for U.S. income tax purposes, a taxpayer can earn gross income up to the standard deduction (projected as $12,550 for 2021) and owe ZERO federal income tax. So, if your child’s total income for 2021 – wages plus all other income such as interest income, etc. – is expected to be under $12,550, they can set their federal income tax withholding at zero. They may still need to withhold state income tax, but if your child is a Louisiana resident and works in Louisiana, they may earn up to $4,500 and owe zero Louisiana income tax as well. If that is the case, they could set their withholding on Form L-4 such that no income tax is withheld. In this case, your child can avoid needing to file an income tax return for 2021.
We often see children of clients filing tax returns to recoup the tax withheld from their wages, but the cost and time to file sometimes outweighs the refund. If the income projected to be earned is under the thresholds above, the time and expense of filing can be avoided, while putting more dollars in their pocket from every paycheck.
If you own a business, employing your child can be a significant benefit from an income tax perspective, but it requires diligent planning and documentation. As noted above, your child’s standard deduction is projected to be $12,550 for 2021. If your child has no other income, your business could pay them up to $12,550 and that income will not be subject to income tax since it will be offset by their standard deduction. Your business would deduct the salary as a regular business expense while your child receives wages free of income tax. In certain situations, the income will not be subject to Social Security or Medicare tax, either. This option may sound too good to be true, but it is subject to several rules and considerations:
As noted above, you still need to diligently plan and document situations where you are employing your child because there are important requirements and considerations aside from the potential tax windfall.
As your teenager or college student embarks upon any new employment, be wary of the impact it may have on your ability to claim your child as a dependent. Depending on your situation, you may still be eligible for the Child Tax Credit, which was substantially enhanced by the 2017 Tax Cuts and Jobs Act (TCJA). In order to claim the Child Tax Credit, your child must still qualify as a dependent. One of the determinations is the “support test,” which states that you must provide at least half of your child’s support for the year. While it is unlikely that a $12,500 or so salary would allow your child to provide more than half of their own support, just be aware of this potential nuance in the event your child has other sources of income.
Whether your child is looking for a summer job or working at the family business this summer, they likely need some guidance in matters of income tax strategy. There are some great potential tax advantages—for your child and possibly for you—that can result from a little careful planning and foresight. Contact your P&N tax advisor for more information.