Once that final bell rings on the last day of school before summer break, the minds of students across the country will immediately shift from history, math, and science to pools, beaches, summer sports leagues and free time. For most, summer jobs will be a means to an end, a way to afford summer fun, and taxes won’t even be on their radar. That’s a dangerous oversight, according to the California Society of CPAs (CalCPA). Understanding the implications of taxes on summer earnings can save student workers both time and money down the road, and the California accountants have a number of tips for how to do so.
1. Understand the IRS forms you 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,” which is used to determine how much tax to withhold from each employee’s paycheck. Federal income taxes operate on a pay-as-you-go basis, you see.
However, most students won’t make enough from their summer jobs to warrant paying income taxes, as they don’t usually kick in until one earns $5,800. This generally doesn’t stop employers from withholding anyway, though, which means students who expect to earn less than $5,800 during 2012 should claim exemption from withholding on the W-4 that they file in order to save themselves the hassle of filing a return to reclaim these tax payments next April.
Keep in mind that appropriate payroll taxes will still be withheld since the payroll-tax threshold is $400 in earnings.
2. Determine your withholding allowances.
For students who are either on track to make more than $5,800 over the course of 2012 or are unable to garner an exemption from withholding, the amount an employer will withhold from each paycheck depends on your salary, marital status, and the number of withholding allowances claimed on your W-4. While most student workers will unfortunately find they can claim only one allowance – a special allowance available to single individuals who have only one job – you should at least explore the possibility of additional allowances, as each reduces the amount of tax withheld. In doing so, remember that you can claim fewer allowances than you’re entitled to but not more than you qualify for.
Additional information on tax withholding allowances can be found on the worksheet that accompanies your W-4 as well as the IRS website.
3. Figure out whether you’re an employee or an independent contractor
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. So if you end up being an independent contractor, make sure to calculate the taxes that you’ll be expected to pay and put that money aside so that you do not find yourself in the unfortunate position of being unable to foot your tax bill.
4. Don’t ignore 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.
5. Understand the tax implications of starting your own business
Students who start summer businesses of any kind don’t have to worry about withholding, as it only covers wages earned by employees. Instead, self-employed students may have to make estimated tax payments to the IRS each quarter, if their businesses are very successful.
You see, 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), and relatively few student businesses will be profitable enough during a single summer to incur a tax bill of $500. Student entrepreneurs should nevertheless keep receipts and other records of their business expenses, which can be deducted against income on their tax returns.
Now that you have foresight when it comes to your tax obligations arising out of a summer job, all that’s left to do is go have fun, make a lot of money, and be mindful of taxes in the process so that come fall you can look back at your summer job as a positive experience, not something that left you buried in debt.