Are Teens Required to File a Tax Return?
By NATP Member, Carol L. Topp, CPA, Cincinnati, OH
National Association of Tax Professionals (NATP) Appleton, WI – Determining whether income earned by minors (which includes teens), is taxable can be a very complicated area, according to Kurt J. Heinz, CPA, an NATP member from Homer Glen, IL. In addition, “Many teens assume they don't have to file and they disregard their W-2s, even throw them out, thus losing out on refunds they could and should claim,” adds NATP member Marilyn Meredith, an enrolled agent in Port Huron, MI.
Here is a little quiz to test your federal tax knowledge. See if you know the correct answers. Yes or no
– do the following teens need to file a federal tax return?
Kurt, age 15, mows lawns for a cemetery using equipment owned by the cemetery. The $1,000 he earned for his efforts in 2006 was reported by the cemetery on a Form 1099-MISC.
Tom, age 19, sold stock that his parents had invested for him. The stock had a capital gain of $5,000.
Laura’s W-2s indicate that the 16-year-old earned $3,100 at her fast-food job, and $3,000 working at a discount store, for a combined total income of $6,100.
Tim put half of all his monetary gifts into savings from the time he was little. Combined with deposits made by his parents, his bank savings account earned $600 in interest in 2006. Tim is 16 and is a student with no wage-earning job.
Kelly, 14, babysits for selected neighbors and also gives piano lessons in her parents’ home. In 2006, Kelly made $1,000 total for these two jobs ($800 from babysitting and $200 from piano lessons).
Seventeen-year-old Jason earned $2,000 in cash doing landscaping work for two neighbors.
At age 15, Brandon already has a good clientele for which he does website design. His work brought in $6,000 during 2006.
Julie’s dad manages a college fund for her in her name. Julie is only 14 and does not work for a wage. During 2006, her dad sold stock for a capital gain of $5,000.
Here are some facts about tax laws as they relate to children under age 18:
A teen under the age of 18 who is also a student during some part of each of any five calendar months in the tax year, is considered a child (or minor) for tax purposes, and therefore subject to tax rules regarding children (often called “kiddie tax”).
Threshold amounts are the amounts at which income becomes taxable. 2006 teen employment thresholds are: earned income, $5,150; unearned income, $850; self-employment (SE), $400. (Most amounts are adjusted annually.)
Earned income is ANY income or wage earned from a job. It includes cash as well as any income for which the worker receives a Form W-2 or Form 1099-MISC.
Unearned income comes from investments such as savings accounts, dividends from stock and mutual funds owned in custodial accounts, and capital gains for the sale of stock or mutual funds. Students with more than $850 of unearned income owe federal income tax.
Self-employment (SE), social security (FICA), and Medicare are all considered SE taxes. Self-employed teens must pay SE tax on any net income over $400 and report their income and SE taxes on Form 1040. Frequently additional forms and schedules are required as well. “However,” notes NATP member, Dawn J. Renner, CPA, from Minnetonka, MN, “Teens under age 18 who work for their parents’ business are not subject to FICA or Medicare tax unless the business is incorporated, a partnership (unless each partner is a parent of the child), or an estate.”
Teens who are household employees do not owe SE tax; however, income is reported on Form 1040, Line 7, broken out from any W-2 wages. The household (also called domestic services) income amount should be indicated with a code of “HSH”. Household employees are housekeepers, maids, babysitters, gardeners, and others who work in or around private
residences as employees.
Kiddie tax is tax assessed on unearned income of children under age 18. This includes taxable interest, dividends, capital gains, etc. Children under the age of 18 will pay tax at their own rate on the first $1,700 of unearned income, but once the threshold is met, children must file IRS Form 8615, Tax for Children Under Age 18 With Investment Income of More Than $1,700, with their tax return to report the income and pay taxes at their parent’s higher rate. For 2006, a child who only has capital gains and qualified dividend income of less than $30,650 is taxed at a capital gain rate of five percent. Unearned income totaling over $1,700 is taxed at the parents’ income tax rate. For 2008-2010 only, the tax rate will be zero for those who have parents in the 10-to-15-percent income tax bracket.
Armed with all that knowledge, are you ready to check your answers? Do these teens need to file a federal income tax return?
1. Yes. Kurt received a Form 1099-MISC and is considered an independent contractor so he must file and pay SE tax, but will not owe federal income tax because his income was under the $5,150 earned income threshold for 2006.
2. Yes. Tom needs to file a Form 1040 and a Schedule D, Capital Gains and Losses. Because Tom is over age 18, he will also pay federal income tax at five percent. He is no longer subject to the kiddie tax rules.
3. Yes. Because Laura made a total of $6,100 (over the threshold), she will need to calculate federal income taxes on Form 1040, and may possibly owe state taxes.
4. No. Because Tim’s interest amount is under the threshold of $800, he does not owe nor need to report his income.
5. Yes. Kelly is a household employee when she babysits unless she advertises her services and offers them to the public. Doing so would make her an independent contractor making her subject to SE taxes. Because she babysits for only selected people and does not advertise, she is a household employee, and owes no SE on the babysitting portion of her income. Wages earned for piano lessons are considered SE income. But because the $200 she made is under the $400 threshold amount, Kelly will not owe SE tax on the income she earned for giving piano lessons. Kelly will owe no federal income tax because her income is under the threshold amount for taxation; however, she still must file an income tax form to report her income from the domestic services (using the code “HSH” to identify it as such).
6. Yes. Jason is considered a household employee with an income below the threshold for federal income tax, so he will need to report his income for domestic services like Kelly (in example 5). If Jason had advertised his services or performed landscaping work for the general public, he would be treated like Kurt in example 1.
7. Yes. Brandon’s income amount exceeds the threshold amount. In addition to filing a federal income tax return, he will owe SE tax and likely, state income taxes. NATP member Daniel Wishnatsky, CFP, from Phoenix, AZ, cautions about another consideration, “For a teen with a lucrative side business, that income can have a direct bearing on whether the parent can claim the child as a qualifying child.”
8. Yes. Because Julie’s capital gain was over the threshold amount for unearned income, she must file a Form 1040 and a Schedule D for capital gains and losses. She also needs to file Form 8615. She will pay income tax at her parents’ tax rate.
Meredith notes, “Each state has separate rules on tax filing. Many cities/counties have local taxes with yet another set of filing requirements. Even though a child earning an income may not be required to file a federal return, that child may be required to file a state or local return.”
How did you do? “Taking the quiz and discussing it with your children provides a good opportunity to educate them about the importance of honesty and integrity in their tax filings,” reflects NATP member Susan Walla, an enrolled agent from Blue Bell, PA. “Many parents shrug off their teenagers' filing responsibilities, and their children notice this and learn from it.”
“There’s a reason no one ever said taxes were child’s play,” says Wishnatsky. “It becomes increasingly beneficial to engage the assistance of an expert. You won’t be sorry.”