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Although most tax planning focuses on adults — after all, they’re usually the ones with taxable income — minors also can be affected by taxes. Parents should become familiar with the “kiddie tax,” certain tax implications of hiring their children and the merits of starting an IRA for teenagers.
This tax was added to the Tax Reform Act of 1986 to prevent wealthier parents from shifting unearned income, such as dividends and interest, to their kids, who usually enjoy lower tax rates.
To that end, if a child — typically, under age 18 or a full-time student under age 24 at the end of the tax year — has unearned income totaling more than $2,100 (for 2015), some of the income may be taxed at his or her parents’ rate, if it’s higher than the child’s.
The tax is reported on Form 8615, “Tax for Certain Children Who Have Unearned Income,” filed with the child’s tax return. However, if the child’s unearned income in 2015 is more than $2,100 but less than $10,500, the parents may be able to include the income on their return, and skip filing a return for their child. They must include Form 8814, “Parents’ Election To Report Child’s Interest and Dividends,” when filing their tax return. Bear in mind that doing so bumps up the parents’ income, which could impact certain deductions or allowances which are based on AGI.
Hiring Your Children
Hiring one’s kids to work in a family business can help instill a work ethic, while the children handle tasks that otherwise might go undone. However, parents considering this must follow a few guidelines. For example, the child should be old enough to handle the responsibilities assigned. He or she should perform real tasks and be paid an appropriate wage. While it may be tempting to hire a child at an exorbitant salary — even if the job’s duties consist of making copies or opening mail — because his or her tax bracket probably is lower than the parents’, the IRS frowns on this practice.
Know the rules: Say the business is a sole proprietorship or partnership in which each partner is a parent of the child, under age 18, who’s working in the business. The child’s wages won’t be subject to Medicare and Social Security taxes.
If the business is a corporation or estate, however, the child’s wages are subject to income tax withholding, as well as Social Security, Medicare and federal unemployment taxes. That’s true even if the child’s parent controls the corporation.
IRAs for Teens
Although retirement is decades away for teenagers, they’re not too young to start saving for it. Given the time value of money, even modest amounts put away from part-time jobs can snowball into a sizable sum by the time teens are ready to tap into the funds. Consider this: $2,000 deposited in a retirement account earning 5% will be nearly $23,000 50 years later, even if no other amounts are deposited. Moreover, having a retirement account can help teens get in the habit of saving money.
Bear in mind that, in order to contribute to an IRA, the teen must have earned income, either in the form of W-2 wages or other compensation. Roth IRAs can be of particular value, especially in situations where the teen’s income isn’t enough to generate any income tax. For 2015, contributions, whether to a Roth or traditional IRA, are limited to the lesser of $5,500 or their taxable compensation for the year.
Typically, the account will need to be opened and held by an adult in the name of the child. When the child reaches age 18 or 21, depending on the state, he or she can assume ownership. However, the balance in the IRA, regardless of size, could have a negative impact when he or she is applying for college financial aid, since the account will be considered an asset of the student.
If you’re overwhelmed by the technicalities of the kiddie tax, take a deep breath and click here to contact us. We are ready to help address your concerns.