5 summer tax tips for working teens

June 22, 2011

By Nancy R. Mandell

University of Massachusetts junior Evan Resnick was thrilled to get a paid summer internship at a medium-sized technology firm on the outskirts of Boston. The 20-year-old computer-science major, who lives in nearby Needham, Massachusetts, is fully aware that the competition for internships — often unpaid — and even summer jobs in the retail and food-service sectors, is fierce. This summer, the number of high school and college students with an internship is expected to outpace the 960,000 who found summer employment last year.

But with a job comes paperwork — IRS forms W4 and W9 that determine how much, if any, of earnings will be withheld as well as an often overlooked but unique opportunity to start lifetime retirement savings with a double tax advantage.

Gina Chironis, a personal financial specialist who is CEO of Clarity Wealth Management in Irvine, California, puts it this way: “Most kids don’t have a clue that if they earn only up to $5,800, they can elect not to have income taxes withheld at all, avoiding the need to file a 1040 next year to in order to recover any refunds due.” The IRS set $5,800 as the standard deduction for a single filer in 2011.

Chironis, a non-practicing CPA who is still seeing the youngest of her four children (ages 17 to 24) through the summer paperwork jungle, insists it is up to parents and their advisers, if necessary, to take responsibility for understanding the consequences of signing on the appropriate line. Without adequate preparation and proper guidance, student workers may lose advantages and savings privileges to which they are entitled.

Time to call in a CPA? Not necessarily. Professional groups like the California Society of Certified Public Accountants offer personal and website guidance designed to understand available tax benefits. Evan was fortunate that his employer emailed him the W4, often a bit baffling to first-time employees, particularly when completing it under pressure in the waiting area of an HR department. (Prospective employees can always ask to take the form home.)

Chose exemptions carefully. The hardest question is the most crucial: how many tax exemptions will you claim? IRS guidelines provided as a worksheet on the first page of the W4 usually work out to only one — the self exemption — or zero for teenagers who generally have no spouse or dependents to claim. Both mean income taxes will be withheld from paychecks, whether they are owed or not

But barring additional income from savings and/or investments, kids who earn $5,800 or less can skip the confusing Personal Allowances Worksheet and proceed to Line 7, just above the signature space, entering ‘”exempt” in the box provided. It is important to understand, says Chironis, that the exemption applies only to income taxes. The employee’s share of payroll taxes — covering Social Security and Medicare — will still be withheld and are not refundable. Hopefully, they will count towards funding those benefits later in life.

Since Evan will earn more than the standard deduction, he was fortunate to have advice from his father — a veteran of summer job paperwork, thanks to Evan’s two older sisters. Together, they reviewed the consequences of the number of exemptions — the fewer exemptions the more tax withheld. On the other hand, claiming too many may generate a bill for unpaid taxes.

Save for retirement. As savvy as Evan’s dad is, he hadn’t considered a savings option that professionals call “an often overlooked opportunity” to take advantage of a youngster’s first $5,000 or less in earnings. The trick is to open a Roth IRA, the retirement savings vehicle that allows tax-free withdrawals of after-tax income starting at age 59 ½ — and penalty-free withdrawals for qualified reasons even sooner. “The benefit is that the tax-exempt contributions can grow without being taxed,” explains Julian Block, an attorney and tax expert in Larchmont, New York. “If they’re (younger than) 59 ½ when they make a withdrawal, any penalty will only be imposed on the earnings in the Roth.”

Watch for self-employment red flag. The floundering economy has led many employers to hire students as contract workers, a category entailing a W9 form rather than W4 — and the tax equivalent of self-employment.

Martin Lager, a certified public accountant and a solo practitioner in New York City, takes particular issue with summer camps that hire teenagers as contract workers. “What I’m finding is kids earning maybe $3,000 for the summer and having as much as $980 withheld. These kids get a double whammy: Not only are income taxes withheld, but they have to pay both sides — employers’ and employees’ share — of payroll taxes, about 15 percent!” And unlike working professionals, Lager points out, these kids don’t have expenses and deductions to offset the obligations.

A tip about tips. Tips are the mainstay of many a student worker’s earnings. “Tips have to be reported even if they’re in cash,” warns Chironis, whose daughter spent a summer waitressing. Employers usually provide staff members with the required IRS Form 4070, which has a log for tracking tips. Tips totaling $20 or more in a month must be reported to employers by the tenth day of the following month so that appropriate income taxes can be withheld.

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