Thrifty Thinking: Summer Youth Employment

Millions of high school and college students seek summer jobs. Faced with rising college expenses and student debt many students are using summer break to increase income. But these students will have to deal with tax paperwork awaiting them when they work this summer. The CaliforniaSociety of Certified Public Accountants (CPA)is the nation’s largest professional, non-profit state association representing more than 40,000 CPAs in the area of tax, audit, accounting and consulting services such as personal finance. CPAs suggest the following steps to help students with tax issues this summer and are available to discuss in more detail each of the following points

Step 1: Understand which IRS forms to fill out.

One of the first things that employers will ask their summer help to do is fill out IRS Form W-4, "Employee's Withholding Allowance Certificate." Employers need this form to figure out how much tax to withhold from each employee's paycheck.

Students who have never held a job before and thought that taxes didn't need to be paid until April 15 will learn a quick lesson from the W-4: The federal income tax is a pay-as-you-go system in which individuals are required to pay tax on income as it's earned during the year, usually by having their employer withhold tax from their paychecks.

It won't be apparent when you fill out the W-4. But when the first paychecks are handed out, most students will find that their employers are withholding far more tax than they'll actually end up owing. And although most students won't end up paying a cent in tax on their summer earnings, relatively few students will be able to escape withholding.

If the worker is an employee whose total earnings for the year won't incur income taxes, he or she should file a W-4 form claiming exemption for withholding. That avoids having to file a return to reclaim tax payments the following year. Appropriate payroll taxes will still be withheld.

Step 2: Understand withholding allowances.

How much tax your employer withholds is based on how much you earn each payday, your marital status and the number of withholding allowances claimed on your W-4. Each allowance reduces the amount of tax withheld. You can claim fewer allowances than you're entitled to, but you aren't allowed to claim more than you qualify for. A worksheet attached to the W-4 is used to determine your withholding allowances.

Unfortunately, most student workers will find they can claim only one allowance--a special allowance available to single individuals who have only one job.

Step 3: Understand if you are an employee or an independent contractor for summer work.

Independent contractors don’t have income or payroll taxes withheld, so they (or their parents) may have an unpleasant surprise when a 1099 form arrives and taxes are due the following spring

Step 4: Don’t forget about tips.

Students who are working as waiters, bartenders, hotel bellhops or other jobs that tend to bring in tips from customers will have some additional withholding paperwork to fill out each month.

If you receive tips totaling $20 or more in a month at your job, you'll need to report the tips to your employer by the 10th day of the following month. Your employer is required to withhold tax for whatever amount of tips you do report. This is usually done by withholding tax from your wages.

The monthly report on tips is usually made on IRS Form 4070, "Employee's Report of Tips to Employer." Most employers distribute the forms to employees. The form is included in IRS Publication 1244, which includes a log you can use to keep a daily record of tips for the month.

Step 5: Understand tax consequences of setting up your own summer business.

Students who have set up their own summer businesses--be it mowing lawns or something else--don't have to worry about withholding -- withholding only covers wages earned by employees.

Instead, self-employed workers are supposed to make estimated tax payments to the IRS each quarter. But most students won't have to worry about making quarterly estimated tax payments, either. That's because there is no penalty for failing to make estimated tax payments if you end up owing less than $500 in tax for the year (after subtracting withholding and credits). Relatively few student businesses will turn out to be profitable enough during the summer to incur a tax bill of $500.

But student entrepreneurs should be sure to keep receipts and other records of their business expenses, which can be deducted against income on their tax returns.

Step 6: Do additional research on other tax benefits for teens and college students.

The California Society of CPAs has created a free Web site of articles, tools and resources to help consumers on this and other personal finance issues.