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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 pie, too.

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 15.

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.

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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 adjust 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 taxes.

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 estimated 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.

-- Updated: Jan. 20, 2005
Read more stories by Kay  Bell
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See Also
Filing the right return could save you tax money
Financial tips and strategies for teens

Summer jobs and teens

Tax glossary
More tax stories

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