As the unemployment rate continues to drop and some visa programs are put on hold, an increasing number of younger people may find it easier to obtain a part-time or summer job. A child with a job gains valuable work experience and earns money that can be important for the family’s financial picture and the child’s future. This column details some of the legal, tax, and financial issues that result from having a working child.
Legal Issues
Age matters when it comes to laws in the workplace. As a general rule, once an individual turns age 18, he is no longer viewed as a child, and is subject to all of the same rules as adults. The federal Fair Labor Standards Act (FLSA) sets the rules on minimum wage and overtime rules for workers. Many, but not all, of these rules also apply to parents who employ their children.
College students often seek summer internships as a way to gain work experience and make connections. The FLSA generally bars unpaid internships; unpaid internships are permissible only if the following six conditions are met:
- The internship, even though it includes actual operation of the facilities of the employer, is similar to training that would be given in an educational environment;
- The internship experience is for the benefit of the intern;
- The intern does not displace regular employees, but works under close supervision of existing staff;
- The employer derives no immediate advantage from the activities of the intern, and on occasion its operations may actually be impeded;
- The intern is not necessarily entitled to a job at the conclusion of the internship; and
- The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.
(“Internship Programs under the Fair Labor Standards Act,” Department of Labor Fact Sheet, April 2010, http://bit.ly/2tKHQpp.)
As a general rule, the minimum employment age is 14; however, those age 14 and 15 may work no more than three hours on school days, or eight hours on nonschool days, and not before 7:00 a.m. or after 7:00 p.m. (except June 1 through Labor Day, when work until 9:00 p.m. is permissible). Special rules apply to younger children in the entertainment industry (see http://bit.ly/2rNjhM5).
It can be beneficial for a parent who owns a business hire a child for the summer. The child gains work experience and earns money, while the parent enjoys tax advantages and the additional help.
Federal law does not require a child to have a work permit, and the Department of Labor (DOL) does not issue them. Many states, however, require a child under age 16 to obtain a work permit or age certificate (http://bit.ly/2sQr6AF). All children must have proof of age (and, where required, eligibility of work) when applying for a job so the employer knows whether any legal restrictions apply.
Tax Issues
Taxation of child’s wages.
For federal income tax purposes, a child can earn up to the amount of the standard deduction for her filing status with no income tax; for 2017, this is $6,350 for a single individual (Revenue Procedures 2016-55, 2016-45, 707). Thus, a child can earn over $18 per hour tax-free, based on a 35-hour week for 10 weeks. The “kiddie tax,” which subjects a child’s income over a threshold amount to the tax rates of the parent, only applies to unearned (investment) income [Internal Revenue Code (IRC) section 1(g)].
If a child expects to owe no federal income tax, he can file an exemption from income tax withholding on Form W-4, Employer’s Withholding Allowance Certificate. To use this exemption, the child must have had no tax liability in the prior year and expect none in the current year.
While wages may be exempt from income tax withholding, there is no parallel treatment for Social Security and Medicare taxes (FICA). A child’s wages are subject to FICA taxes, unless the child works for a parent’s company.
Tax considerations for parents.
The fact that a child works may not prevent the parent from claiming a dependency exemption for the child ($4,050 in 2017). The earnings, regardless of amount, do not bar a dependency exemption for a child under age 24 who is a full-time student, as long as the child does not provide more than half of her support, has the same principal place of abode, and is a member of the parent’s household when not away at school or for other temporary purpose [IRC section 152(c)].
Working at a summer or part-time job usually does not affect the amount of child support; however, parents should review their divorce or other relevant agreement to see whether a child’s earnings have any impact on child support.
Putting your child on the payroll.
It can be beneficial for a parent who owns a business hire a child for the summer. The child gains work experience and earns money, while the parent enjoys tax advantages and the additional help.
Parents can deduct wages paid to a child as a business expense only if the compensation is reasonable for the work performed. A parent is not required to pay minimum wage (an exception to the FLSA), but should pay a reasonable rate. It is highly advisable to document the hours that the child works and the type of services performed to support the claimed deduction. The IRS looks at family-related tax positions with greater scrutiny; for example, in one Tax Court case, a mother with a tax preparation business who used her three children to do some clerical work was denied a deduction for their compensation because she did not issue them paychecks and could not show any correlation between work performed and amounts paid (Ross v. Comm’r, TC Summary Opinion 2014-68).
If the parent is a sole proprietor or the company is a partnership in which each parent is a partner, any amount of wages paid to a child under age 18 is exempt from FICA [IRC section 3121(b)(3)(A)]. Wages paid to a child under age 21 are exempt from federal unemployment tax [IRC section 3306(c)(5)]; however, these exemptions do not apply if the parent’s business is a corporation or a partnership wherein any partner is not a parent of the child.
Financial Issues
Having a child who works can create both advantages and disadvantages from a financial perspective. The child can start a lifetime habit of earning income and savings and begin to set aside money for retirement on a tax-advantaged basis; however, working can adversely impact financial aid.
Fiscal responsibility.
Earning money is an opportunity for a child to learn how to manage it: what should be saved, what should be spent, and even what should be donated. Having a child set financial goals with respect to her earnings can be a valuable life lesson.
Retirement savings.
Having earned income means the child can fund an IRA or Roth IRA.
A child who needs financial aid to meet education costs should take earnings from a summer or part-time job into account.
The child does not have to use her earnings to make the contribution; the earnings can be spent, donated, or saved in a different account. The contribution can also be made by a parent or grandparent based upon the child’s earnings. The maximum contribution is the lesser of the child’s earnings or $5,500; thus, if a child earns $3,000 for the summer, the contribution is limited to $3,000. The child can use funds from the IRA to pay for higher education, but the distribution is taxable; however, there is no 10% early distribution penalty [IRC section 72(t)(2)(E)].
As a general rule, it may be better to contribute to a Roth IRA because of the long time until retirement (IRC section 408A). While no deduction can be claimed for the Roth IRA contribution, the earnings grow to create a tax-free retirement fund. If the child does not want to make investment decisions or risk any losses, he can contribute to a myRA, which is like a mini-Roth IRA (https://myra.gov/).
CHECKLIST
- ___ Does my child need a work permit or age certificate?
- ___ Has my child started to look for summer employment?
- ___ Does my child understand whether an internship is paid or unpaid?
- ___ Have my child’s earnings been saved in an IRA or Roth IRA?
- ___ What happens if I put my child on my payroll?
- ___ What effect will my child’s earnings have on FAFSA?
- ___ Has my child set financial goals with respect to earnings?
Even though the child may have low income, she cannot take the retirement saver credit, a tax break that allows those contributing to a retirement plan to receive a tax break for the contribution and a tax credit (IRC section 25B). Anyone who can be claimed as another taxpayer’s dependent is barred from claiming the retirement saver credit.
Financial aid.
A child who needs financial aid to meet education costs should take earnings from a summer or part-time job into account. The Free Application for Federal Student Aid (FAFSA) allocates half of a student’s income for the upcoming college year, including money from working (other than work-study income) and withdrawals from IRAs. A parent’s income contribution ranges from 22% to 47%.
In addition to income, a child’s and parents’ assets are factored into the financial aid formula. Under this formula, a child is required to use 20% of assets; parents are only required to use 5.64% of assets. Earnings placed in a savings account are an asset in the FAFSA formula; however, “protected assets,” which include IRA savings, do not.
