Welcome to the working -- and tax -- world
You got your first after-school job. Now you understand
why your parents always complain about taxes.
The boss said you'd be making $150 week. So how come
your check is for a lot less than that? New employee, meet Uncle
Sam. He's the one taking a chunk of your spending money. His cousin,
the state tax collector, could be getting a piece of your earnings
This is because of payroll withholding, which basically
is pay-as-you-earn taxation. While the Internal Revenue Service
trusts us to file our taxes accurately and on time, the U.S. Treasury
finds it easier to pay for federal programs if it gets some of the
money throughout the year instead of in one big batch each April
Where you live or work also could cost you. In many
areas, an employer will withhold state income tax (and sometimes
city or other local levies) from your checks. This means before
you receive any money, various taxes are taken out, deposited in
an IRS or state account and credited to you when you file your returns.
Even those tips
you rake in as the restaurant's best server are taxable. Your employer
must withhold taxes on them. How does he know how much? If you make
more than $20 a month, you must tell your boss the exact amount
so he can withhold the appropriate taxes from your regular wages.
And income taxes aren't the only thing taken from
your pay. Most employers must withhold 7.65 percent of your paycheck
to go toward Social Security (shown on most pay stubs as FICA) and
Medicare. This assessment isn't all bad. First, by paying into these
benefit plans now, you'll be eligible to collect on them later in
life. Second, your boss contributes the same percentage amount on
your behalf, making your eventual benefits pool bigger.
Taking tax control
While every salaried employee, regardless of age, generally encounters
payroll tax withholding, you're not without options. Workers can
the amount of income tax withheld so that the IRS doesn't get
too much upfront.
A W-4 was among the paperwork you filled out on your
first day on the job. Here you told your boss how much income tax
to take out each paycheck. For most student workers, one allowance
usually is appropriate. But in some cases, a young taxpayer may
be exempt from withholding.
You can ask your employer not to withhold income taxes
from your pay if you didn't have a tax liability for the preceding
year and you don't expect to owe any tax for the current year. Even
though you are a student still living with your folks, the exemption
is not automatic. You must fill out line 7 on your W-4.
Keep in mind, however, that if you're thinking of
telling your boss not to withhold income taxes, you need to consider
your total expected income. The IRS says if you're claimed as a
dependent on your parents' tax return, you can't avoid withholding
if your total income is more than $800 and more than $250 of that
comes from interest or dividend earnings.
Finally, if you are eligible for the withholding exemption,
claiming it will stop only income tax collection from your paycheck.
Your boss will continue to take out Medicare and Social Security
Teen entrepreneurs and taxes
Some teens don't worry about payroll withholding or tip reporting.
That's because they're in business for themselves.
But running your own lawn-mowing or dog-walking service
won't let you off the IRS hook. In fact, your tax responsibilities
are more complex. Depending on how successful your venture is, in
addition to owing income tax, you might have to come up with self-employment
tax payments to cover Social Security and Medicare contributions.
The IRS expects these taxes when your self-employment
income is more than $400. Complete Schedule
1040SE to figure your self-employment liability and file it
along with your individual tax return. (Do you have a lucrative
paper route? Stop worrying. The IRS says newspaper carriers, distributors
or vendors younger than 18 don't have to pay self-employment taxes.)
If your entrepreneurial enterprise is very profitable,
you could have even more tax paperwork. The IRS expects quarterly
tax filings if your tax bill, including self-employment amounts,
comes to more than $1,000. Your business wasn't quite that good?
Then you don't have to worry about estimated taxes, but you should
consider putting away a portion of your earnings to pay whatever
taxes you might owe come April 15.
Filing your first return
OK, you now understand making money does have a downside: paying
taxes. But since you didn't earn that much and taxes were already
withheld, do you still have to hassle with all those forms? It depends.
The good news is that Uncle Sam considers you more
grown up than a lot of the adults you deal with daily. The bad news
is that because of that respect, the IRS wants some documentation.
Generally, a young person is responsible for filing
his or her own tax return and paying any tax due. But the IRS does
have some guidelines based upon:
- Whether you can be claimed as a dependent on someone
else's (usually a parent's) tax return,
- How much gross income you received, and
- What kinds of income you got.
A youth who is claimed as a dependent must file a
tax return if he earns more than the standard single-filer's deduction
amount. For 2004 returns, that's any amount above $4,850.
But you may have to file a return even if you didn't
have a job. That's the case if your investment income, classified
as unearned income by the IRS, was more than $800.
When you collect both unearned income and wages, the
IRS looks at what it calls gross income to decide whether you must
file. A young person has to submit a return if the total he receives
is more than either $800 or his earned income amount plus $250,
whichever amount is larger. For example, you got interest income
of $325 and made $450 working a concession stand at the county fair.
Your gross income is $775 and your earned income plus $250 comes
to $700. The larger amount -- $775 -- is still less than the $800
threshold, so you don't have to file a return.
And even if you don't legally have to file, it could
pay to send in a return anyway. Were income taxes withheld from
your pay? If too much was taken out, the only way you can get it
back is to send in a return.