United States: School Is Out And Summer Employment Is In: Tax Tips For Students

Employment during the summer is a great opportunity for students to build a résumé, gain experience, create valuable connections and develop some financial independence. Summer jobs can also provide students with spending money, assist with college tuition payments (or more realistically, one semester of books) and potentially offer practical experience for a future career. Summer employment offers experiences often not available or cannot be replicated in a classroom.

Along with such benefits, summer employment will introduce students to a five-letter word that up until this point in life probably had very little meaning, but will affect them regardless of the amount of income earned—taxes! They will learn the reality that earning $15 an hour does not equate to $15 an hour in their pocket. 

Here are a few notable tax tips for students with or contemplating summer jobs: 

Employee Paperwork

When you get a new job, you will need to complete IRS Form W-4, Employee's Withholding Allowance Certificate. Employers use this form to determine how much federal income tax to withhold from your pay. The lower the number of "exemptions" claimed, the higher your income tax withholding. Conversely, the higher the number of "exemptions" claimed, the lower your income tax withholding.  Irrespective of amounts withheld for income taxes, Social Security and Medicare tax will be withheld at a 6.2 percent and 1.45 percent rate, respectively, and is not available for refund unless you earn more than $118,500. A student should be so lucky.

If you are treated as an employee, your employer withholds tax from your paychecks. If you are treated as self-employed (think babysitting, lawn care, painting—see Self Employed Individuals), you may have to pay estimated tax directly to the IRS on set dates during the year. If you earn $400 or more, you will need to file a federal tax return.

Self Employed Individuals

Like many students, you may have multiple informal jobs, such as babysitting, lawn care, hardscaping, painting, swimming lessons and the like. Earning $400 or more may subject you to self-employment tax reporting. While self-employment income can be offset by qualified expenses incurred for the production of the self-employment income, it is crucial to keep detailed records of receipts and expenses incurred and paid. Also, be aware of the hobby loss rules, which limits the deduction of losses from income when there is no profit motive. The hobby loss rules are complex and beyond the scope of this Alert. However, if you or a family member is self-employed, be sure to seek professional advice for proper tax reporting guidance. Under either an employee or self-employed situation, it is prudent to set aside money to pay the tax that may be due when the returns are filed.

Employed by Parent

Working with mom or dad has many non-tax and tax benefits. From a tax perspective, bona fide wages paid by a parent to a child who is under the age of 18 are not subject to Social Security and Medicare taxes, or Federal Unemployment Tax (FUTA). Wages paid to your child who is 18 years or older, but under 21, are not subject to FUTA. Additionally, parents may claim the child's wages as a deductible business expense provided the child is treated as a regular employee, wages are paid in dollars (as opposed to food, shelter, etc.) and a W-2, Wage and Tax Statement is filed.

Keep Track of Your Expenses

You may be eligible for several tax deductions such as union and professional dues, qualified education expenses and job-related expenses if you itemize expenses on your tax return. Moving expenses and student loan interest may also be deductible, whether or not you itemize expenses. Keep close track of your expenses and you may be able to reduce your tax liability. Then consider investing the refund in a Roth IRA (see Retirement Planning).

Tip Income

The service industry is where many students land summer employment and where compensation is primarily tip driven. All tip income is taxable. Any cash tips of $20 or more per month are required to be reported to the employer. Also, you must report all of your yearly tips on your tax return.

The key to accurately reporting tip income is organization and detailed recordkeeping. In the event of an IRS audit targeting unreported tip income, interest and penalty assessments can be significant. There are a variety of recordkeeping techniques and resources available to assist with accurate reporting of tip income, including tip tracking apps. Popular apps, such as Just the Tips, TipSee and Tip Log, may help keep track of daily, weekly and monthly tips as they are earned and recorded.

Out-of-State Employment Adds Complexity

Another consideration to keep in mind while engaged in seasonal employment is the job location. Physically working in one state but residing in another state can add certain complexities to tax reporting, including the filing of additional state income tax returns. In most  states, taxes will be withheld and paid to the state of employment. 

However, reciprocal agreements, which many states have in place with neighboring states, eliminate the complexity and the need for non-resident state tax withholding from the wages of non-resident seasonal employees. For example, if you reside in Pennsylvania but work in Indiana, Maryland, New Jersey, Ohio, Virginia or West Virginia, the out-of-state employer will withhold Pennsylvania income taxes with no taxes withheld or paid to that employer’s state. The table below summarizes states with reciprocal agreements presently in place.

States with Reciprocal Agreements

Resident State State You Are Employed In
Any State District of Columbia
Illinois Iowa, Kentucky, Michigan or Wisconsin
Indiana Kentucky, Michigan, Ohio, Virginia, West Virginia or Wisconsin
Iowa Illinois
Kentucky Illinois, Indiana, Michigan, Ohio, Virginia, West Virginia or Wisconsin
Maryland District of Columbia, Pennsylvania, Virginia or West Virginia
Michigan Illinois, Indiana, Kentucky, Minnesota, Ohio or Wisconsin
Minnesota Michigan or North Dakota
Montana North Dakota
New Jersey* Pennsylvania
North Dakota Minnesota
Ohio Indiana, Kentucky, Michigan, Pennsylvania or West Virginia
Pennsylvania Indiana, Maryland, New Jersey, Ohio, Virginia or West Virginia
Virginia District of Columbia, Kentucky, Maryland, Pennsylvania or West Virginia
West Virginia Kentucky, Maryland, Ohio, Pennsylvania or Virginia
Wisconsin Illinois, Indiana, Kentucky or Michigan

* New Jersey has proposed legislation to eliminate the reciprocal agreement in place with Pennsylvania.

If you are working in a state without a reciprocal agreement with your resident state, you will be  subject to both resident and non-resident state income taxes. For example, if you reside in Pennsylvania but work in New York, you will need to file in both states. However, in most cases a credit for taxes paid to the non-resident state will be available on your resident state tax return subject to certain limitations. Multi-state tax reporting is complex and rules vary from state to state, so be sure to seek professional advice if you find yourself in this situation.

Retirement Planning

It’s never too early for retirement planning and wealth accumulation. The power of compounding is magical. Students with summer jobs should consider contributing to a Roth IRA. Since contributions to a Roth IRA are funded with after-tax dollars, they provide for tax-free growth and more importantly tax-free distributions in retirement. The only eligibility requirement to contribute to a Roth, assuming the student’s income will not exceed income limitations, would be earned income. You can contribute up to the amount of money earned for the year, with a maximum contribution of $5,500. So, a yearly contribution of $5,500 for the first six years with no additional contributions for 40 years until retirement at 6.5 percent annually results in a whopping balance of nearly $500,000.

If you would like more information about this topic or your own unique situation, please contact Rodney N. Anello, EA, or the Tax Accounting Group practitioner with whom you are regularly in contact. For information about other pertinent tax topics, please visit our publications page located here.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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