As children move toward adulthood, parents face several milestone decisions. In each case, part of the decision involves a desire to help children become more independent and responsible. But there is another milestone that parents might not anticipate, even though it will be part of almost every child's growing-up experience and (unlike car keys and credit cards) it is legally required. It's the filing of the first income tax return in a child's name.
As parents should realize, income tax filing is not taught in schools and it's not a subject that captivates teens' attention on TV. Most children have only a dim idea of what income taxes are, let alone the specific rules they are required to meet. Therefore, the parent's role is to initiate this rite of passage by evaluating tax-filing requirements and/or obtaining guidance from tax professionals. This article is designed as a parent's "quick guide" to this subject. It covers the basic rules that you should know for determining when your child must (or should) file. It also offers suggestions for helping children take responsibility for their own tax chores in the future.
A Quick Parental Guide to Taxes
Let's begin by describing three basic reasons why children should file federal income tax returns:
- Filing a tax return is required by the Internal Revenue Service (IRS) if the child's income is above a certain level
- Filing can help to recover taxes that have been withheld by your child's employer
- Filing helps to educate children and establish good financial habits that will continue into adulthood
When Children Must File
Children can be claimed as dependents provided that they meet one of the following categories:
- Under the age of 19 at the end of the calendar year and younger than the claimant (or the claimant's spouse when filing jointly)
- Under the age of 24 at the end of the calendar year, a student and younger than claimant (of the claimant's spouse when filing jointly)
- Any age is permanently and totally disabled
To claim an exemption for a dependent child, the taxpayer must provide at least 50% of the child's support and the child must live with the adult at least half of the year. Parents, stepparents, foster parents, siblings and grandparents may claim children as dependents.
Qualifying as a dependent does not mean a child is exempt from filing income taxes. Four basic tests determine this, any one of which requires a federal income tax return to be filed for a given year:
Amounts shown are for 2018 (taxes due April 15, 2019). The IRS' Publication 929 (2017), Tax Rules for Children and Dependents offers more details.
Additional rules apply for children who are blind, who owe Social Security and Medicare taxes on tips or wages not reported to or withheld by the employer, or those who receive wages from churches exempt from employer Social Security and Medicare taxes. Consult a qualified tax professional for details.
If filing a return is required by the first test above and the child has no other income except unearned income, parents can avoid a separate filing for the child by making an election described later in this article.
Example - When to File
Johnny is 17 years old and is claimed as a dependent on his parents' tax return. He earned $100 in interest income from a bank account in his name (unearned), $1,500 working part-time in a gas station (earned) and $200 mowing lawns (self-employment). He does not have to file because he does not meet any of the four tests.
Many states have filing requirements for children that parallel federal rules; however, it is important to check with a qualified tax advisor for details regarding state filing rules.
When Filing Can Recover Taxes Withheld
Some employers automatically withhold part of pay for income taxes. By filing Form W-4 in advance, children who do not expect to owe any income tax can request an exemption. If the employer has already withheld taxes, the child should file a return to receive a refund from the IRS.
The simplest way to file is to use the one-page IRS Form 1040EZ, which can be found on the IRS website. The child must sign the form, attach a copy of any Form W-2 provided by the employer and the IRS will process the refund. Even if the amounts withheld are small, parents should still assist their child with filing the Form 1040 EZ to request a refund. It is quick, simple and – most importantly – it teaches the child that every tax dollar counts.
When Filing Is Educational
Filing income taxes can teach children how the U.S. tax system works while helping them create sound filing habits early in life. In some cases, it also can help children start saving money or earning benefits for the future.
In the example above, Johnny earned money from mowing lawns. Johnny is not required to file a tax return unless net profit from self-employment is $400 or more; however, it might be a good idea to report self-employment income, for two reasons:
- Earning Social Security work credits – Children can begin earnings work credits toward future Social Security and Medicare benefits when they earn a sufficient amount of money, file the appropriate tax returns and pay Federal Insurance Contribution Act (FICA) or self-employment tax.
- Start an IRA – By declaring his self-employment income, Johnny becomes eligible to start a traditional or Roth IRA and contribute up to 100% of net income from self-employment. Since a child's income is often low, a Roth may be the better choice (see Roth vs. Traditional IRA: Which Is Right for You?).
Children can file Form 1040EZ and attach a Schedule C-EZ to report business profits.
What Parents Should Understand
When it comes to filing their children's income taxes, parents need to know the following:
- Legally, children bear primary responsibility for filing and signing their own income tax returns. This responsibility can begin at any age, perhaps well before children become eligible to vote. According to IRS Publication 929, "If a child cannot file his or her own return for any reason, such as age, the child's parent or guardian is responsible for filing a return on his or her behalf."
- Children can receive tax deficiency notices and even be audited. If this happens, parents should immediately notify the IRS that the action concerns a child. According to IRS Publication 929, "The IRS will try to resolve the matter with the parent(s) or guardian(s) of the child consistent with their authority."
- Parents can sometimes skip filing a separate tax return for their child. If a child would be required to file a tax return but his or her only income consists of interest, dividends and capital gains (unearned income), parents may elect to include the child's income on their own tax returns and avoid a separate filing. Consult a tax professional to determine if this choice is available or the best option. Note that for 2017, if the income is above $2,100, the money is generally taxed at the parents' tax rates instead of the child's, if the parents' rate is higher. Under the new tax bill, starting in 2018 until the end of 2025, this "kiddie tax" income will instead be taxed according to the trusts-and-estates brackets, which may be higher for some middle-income families where a child has significant unearned income (more than $12,500 hits the top bracket of 37%).
- Significant self-employment income requires paying self-employment tax. Children who earn net self-employment income above the filing threshold ($400 – or $101.28 if employed by a church exempt from employer Social Security and Medicare taxes) are required to pay self-employment tax for Social Security and Medicare, even if no income tax is owed. The tax is assessed at a rate of 12.4% of net self-employment income (up to $127,200) reported, plus 2.9% Medicare tax (no income limit), for a total of 15.3%. If this applies to your child, attach Form SE to your child's tax return.
Ideas Parents Should Communicate with Children
Discuss the following information with your children:
- When your children start working, sit down with them and discuss their first paycheck stub. It will show gross earnings, any deductions for income taxes and any deductions for FICA taxes (Social Security and Medicare). Explain that the child probably can receive a refund of any income taxes withheld; however, FICA deductions will not be refunded and will continue to be withheld from earned wages. This is a good time to explain the basics of Social Security and Medicare and the benefits of earning credits in these programs.
- If it looks like their self-employment income will exceed $400, have the same discussion about that process.
- Explain that two pieces of information are required on every income tax form: the taxpayer's name and tax identification number (usually the Social Security number for children). The IRS wants these two items to match the data it has on file and problems will arise if there is a discrepancy. Remind the child to avoid using nicknames on tax returns.
- Emphasize to children that individual income tax returns are due by April 15 of the following calendar year, but there is no penalty for filing earlier. Encourage them that filing early is generally a good habit.
- Explain that tax returns contain confidential information that should be protected from prying eyes. Set a good example by filing away completed returns and copies in a secure place.
- Encourage children to sign their own tax forms and explain that the signature attests to the form's truth, accuracy and completeness under penalty of perjury. Emphasize that perjury means "telling a lie under oath" to emphasize the need for honesty in filing taxes.
- Reinforce the importance of paying attention to taxes, filing on time and taking IRS obligations seriously.
The Bottom Line
As discussed above, it is up to parents to teach income-tax filing to their kids. The best way to educate your child about taxes, returns and the value of a dollar is to start teaching early and walk them through the process a few times initially. You must fully explain the reasons for each action they are taking and if you don't know the answers to their questions, make sure to talk to a financial professional who does.