When the heat is on, so is the pressure for kids to find jobs for the summer. Earning extra cash for the summer runs the gamut from lifeguard to babysitter to office jobs and entrepreneurial efforts such as lemonade and popsicle stands.
No matter the job your child chooses to do this summer, if it’s for pay, there will be tax consequences — and depending on the age of the child and the amount of the cash, those tax consequences might affect you, as the parent, too.
In 1986, Congress passed a law known as the “kiddie tax” to prevent parents from shifting income to their children in a lower tax bracket. The tax applies to children who are dependents. Those who are not dependents because of their age or filing status (such as children who are married), level of support or those who are emancipated have a different set of rules.
How the kiddie tax works
Children under the age of 19, or those 23 and under while a full-time student, who receive unearned income do not pay tax on that income to the extent that the income is below certain limits. Unearned income tends to be income from investments, including dividends and interest. For 2013, those limits are:
- The first $1,000 of unearned income is considered tax-free; and
- The next $1,000 is taxed at the child’s rate as determined by the tax brackets.
- Unearned income over that combined amount ($2,000 for 2013) is taxed at the child’s parents’ tax rate.
A child who turns 20 (or 24) by the end of the tax year is not subject to the kiddie tax, regardless of the amount or type of income. Similarly, as previously noted, married and emancipated children are not subject to the kiddie tax rules.
Of course, just because income might be taxed at the child’s parents’ tax rate does not mean that income has to be included on the parents’ tax return. You can choose to file a separate return for your child (again, with the amount over $2,000 taxed at your rate) or the income can be included on the parents’ return if the child’s interest and dividend income totals less than $9,500.
In the event that the child’s parents are divorced, generally, the kiddie tax is reported on the custodial parent’s tax return. In the event that the child’s parents are unmarried — and have never been married to each other — or if the child’s parents are married but filing separate, the kiddie tax is calculated using the parent’s return with the highest taxable income.
Does your child need to file?
So long as children and other dependents have earned income less than $6,100, there’s generally no need to file a federal income tax return. Earned income is income made from wages, salary or self-employment; tips are also considered earned income. It’s important to note, however, that even if your child doesn’t have to file his or her own federal income tax return, he or she may want to file if federal income tax was withheld from his or her check or if your child qualifies for certain credits which would result in a refund.
Unlike unearned income, the amount of earned income is not subject to limits and the rate of tax is the child’s own rate.
If your child works for tips, those are taxable, too. Your child needs to keep great records since tips are not always reported on a form W-2 or 1099 (there are some exceptions). I highly recommend keeping a tip journal to track tips. Simply jot down the total amount of tips each week. The IRS will generally accept a tip journal as proof of compensation.
And what about that lemonade stand?
Self-employment income, meaning income from a business, is treated a little different from wages. It’s still considered earned income for purposes of the kiddie tax but if your child has net earnings of $400 or more, he or she may be subject to self-employment tax.
Depending on the amount and source of the income — as well as the age of your child — the kiddie tax can be as simple to report as entering information from a form W-2 into a tax software program or as difficult as figuring how to report self-employment tax. It’s even more complicated if there is a mix of earned and unearned income.
Summer jobs are a rite of passage — but tax audits don’t have to be. If you’re not sure how to report and pay tax on your child’s income, be sure to ask a tax professional for assistance.