Financial Literacy for Teens: Earnings and Taxes

Whether it’s mowing lawns, working part-time in an office or making jewelry, your teen’s first job is a chance for you to teach them about one aspect of employment they may not consider—taxes.

Once your teen starts working, they’ll probably notice money withheld from each paycheck. While it can be disappointing to see their paychecks shrink, it’s also a chance to learn how money and taxes work so they won’t be blindsided in adulthood.

How Can I Prep My Teen for Their First Paycheck?

Taxes are withheld from an employee’s wages to fund the government. These include federal income taxes, Social Security and Medicare. If your state imposes income tax on earnings, your employer would withhold this money from your teen’s paycheck too.

The FICA tax (the Federal Insurance Contributions Act) includes Social Security and Medicare withholding. The IRS’ current tax rate for Social Security is 12.4% (the employee pays 6.2%, and the employer pays the other 6.2%). Medicare tax is currently 2.9%, with the employer and employee each paying half.

Your teen’s employer will ask them to fill out IRS Form W-4. This form tells the employer how much federal and/or state tax to withhold based on whether the employee is married, has dependents or works multiple jobs. 

When your teen fills out the form, remind them how important it is to protect their Social Security number. They should only share it with people or businesses who have a legitimate need for it, such as their employer. At the beginning of each year, employers issue W-2 forms that show how much money they paid and withheld from each employee in the previous year.

If you are a sole proprietor or have a partnership with your spouse and you hire your child who is under age 18 to work in the family business, you may not need to worry about payroll taxes. Find out why.

What About Self-Employment Taxes?

If your teen earns more than $400 in a calendar year as an independent contractor, they may owe self-employment tax. Because self-employed people don’t have an employer paying half of their FICA taxes, they pay all of it. However, they may be able to deduct certain business-related expenses, which lowers the amount of taxable income. Self-employed people report their income on a Schedule C. And, use Schedule SE (Form 1040) to determine the taxes they owe.

Does My Teenager Have to File a Tax Return?

Maybe. If their earned income (money from a job or a business) was more than $12,400 for 2020 ($12,550 for 2021) or their unearned income (money from investments) was more than $1,100 in one calendar year, then the IRS requires them to file a tax return, even though you claim them as a dependent on your tax return.

Even if your teen earned less than those amounts, they can still file a tax return. It might be beneficial for them to do so. For example, if they had federal income taxes withheld from their pay, the IRS recommends that they file a tax return to get some, or perhaps even all, of that withholding back.

If My Teen Has a Job, Can They Open an IRA?

Yes, minors can contribute to an IRA if they have earned income. A parent or guardian manages the account as a custodian or “responsible individual” while the teen is still a minor. They can contribute the full amount of their earned income (or up to $6,000, whichever is lower).

Contributions to Traditional IRAs may be deductible when they file their tax return. But unless your teen is a tech whiz making big bucks from a hot new app or an entertainer getting large residual checks, they’re likely at the lowest available tax rate now. In that case, contributing to a Roth IRA is usually a better option. With a Roth IRA, your teen pays taxes on the money the year they earned it but can enjoy tax-free qualified withdrawals later in life.

Note that they aren't required to file an income tax return to make IRA contributions if their earned income is less than the standard deduction ($12,400 in 2020, $12,550 in 2021). 

Prepare for Their Future

You can help your teen prepare for the future by helping them understand how much their earnings are taxed. If you have questions about your specific tax situation, consult an accountant. For more on starting your child or teen’s financial education, check out Raising Financially Aware Kids.