Do you remember the first time as a kid you had to file your taxes? I do. It was back when I got my very first job – actually jobs, working in a restaurant and then at a local amusement park in the summer. This is when my father executed his non-patented strategy to get me involved in retirement savings, and gave me a parental match to help me open my first IRA.
Interestingly, I’ve always found it difficult to find a lot of good information online about kids and money, which is one of the reasons I write about it so often. The information I’ve seen is often so general it’s useless. So today, in case you too are interested in getting some more specifics, I’m going to talk a bit about kids and taxes. Note that I’m not a tax expert, I’m a tax hobbyist, so please do your own research and consider talking to a CPA if you have questions.
So…Does My Kid Have To File Taxes?
There are two major kinds of income you need to think about here, to answer this question for your own kids (your dependents):
Question 1 – Does my kid have earned income? This is income from a job – maybe working in a restaurant or amusement park like I did, or babysitting, mowing lawns, and so on. The key here for 2017 is $6,350. If they earned more than that, they need to file taxes. Neither of my kids currently fall into this, although I expect my older son will shortly. He’s 14, turning 15 in October, and so next year he’ll be able to (*cough, will, cough*) get a job.
Question 2 – Does my kid have unearned income – interest, dividends, capital gains? If this is the case, the number you’ll want to know in 2017 is $1,050. My kids are below this – most of their college money is in 529’s or savings bonds, which don’t throw off interest each year. They do each have savings accounts and some taxable investments that were a gift from a grandparent. Since of course they’re invested in tax-efficient funds, there aren’t a lot of dividends/capital gains to worry about.
If they have both, the rules are a bit more complex – their gross income has to be more than the larger of $1,050 or earned income (up to $6k) plus $350. Here’s the IRS publication for more info and the worksheets.
If My Kids Don’t Have To File, Should They?
There are two reasons to help your kids file their taxes, even if technically they don’t “need to”:
–They might have had tax withheld from their paycheck. Filing a return will get it back for them. This is a great opportunity to teach them how to read their pay stub.
–They might need to learn how to file taxes. Their tax returns will never be easier than when they only have a part-time teenage job. This is the perfect time to teach them all about taxes. Like how to read the tax forms and publications. Or how to find information about taxes online. Heck, this teaches them how to actually do the filing. These are important adult lessons your kids need to learn – and learning it early will only help them.
Helping Your Kids To Owe Less Taxes – Today & Forever
One of the most powerful financial gifts you can give your children is the knowledge of compound interest. A dollar invested today is worth $2, then $4, $8, $16 and so on down the line.
My father had a good idea with his IRA match, but it was before the Roth IRA/right after it was developed. Because yes, I’m oldish – when the Roth was created in 1997 I was 17. I don’t think my father even knew what it was. But now, I most certainly know what it is, and that’s straight where my matching offer is going.
As long as your child has earned income over the IRA threshold – right now $5,500 – they can max it out right away. Heck, even if their income is lower you can contribute an amount equal to what they earned. So if they bring in $1,000 from side jobs, that amount can go into the IRA. They should participate in this process, rather than just have a parent do all the funding for them, so they learn and feel ownership over the process. So sit down with your child/teen before they get that job, teach them about compound interest, and discuss what kind of match you’ll be offering (if any).
You could offer to match fifty cents per dollar, dollar for dollar, or be generous and give them two bucks for every dollar. Even if you pick a smaller match percentage, it’s a great way to encourage savings and investment. Not only that, but your kids sees an immediate “return” on their money. That first job is also a good time to start teaching these lessons, because:
(1) You still have control over the accounts until they turn 18, so they can’t empty them and buy a car
(2) It will give them practice in saving and investing before they hit “real world” salaries and make bad decisions with extra zeros
(3) It will give them a triple tax advantage – tax free/low tax now, tax free growth, tax free distributions
Thinking About The FAFSA
While you’re thinking about taxes, you’ll also want to think about the FAFSA (Free Application For Student Aid). Retirement accounts in kids names aren’t counted against them in the financial aid calculations, but savings and investment accounts sure are.
What does this mean? If your kids are receiving over $1k in returns per year, they probably have substantial assets in their name. Those assets need to be reported when you fill in the financial aid form, and your kids are expected to pay 20% of their assets towards college each year. It also expects 50% of your child’s income to be paid toward school. This doesn’t matter if you’re a high income earner and expect to get no financial aid. So don’t let the FAFSA tail wag the financial decision dog. I’ll write more about the strategy in detail in a few weeks.
I Want To Hear From You!
Have you had the “tax talk” with your kids? Any tips on kids and taxes I – and your fellow readers – should know about? Let me know in the comments!
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