[Editor's Note: This is our second column from my daughter Whitney, a paid columnist here at WCI. If you (or your kid) missed her first column, you might want to read that first. Since Whitney was 12 years old in April, I figured she was old enough to do her own taxes, so she did. In this column, she explains what she learned from the process. Since her taxes are more complicated than those of most residents, perhaps this will give you the motivation to do your own. Reminder- be extra nice in the comments section as I'm trying to encourage my daughter's work and learning.]
Thank you to everyone who asked me questions and gave some nice feedback on my last column. This year I filed my taxes for the first time. Up until this point my dad filed all my taxes. This is also the first year that I owed any taxes. So here are
12 Things I Learned From Filing My Own Taxes For The First Time
# 1 Why I Filed Taxes At All
Lots of my friends babysit, but I don't think they all tell the IRS about their income. They don't have to if it is less than $400. I told the IRS about my babysitting money not only because I made more than $400, but because I wanted to put it in a Roth IRA for retirement, and I figured if I was going to do that I better report it to the IRS. My dad figured I should probably learn how to do my taxes, and this year my dad gave me the “Daddy Match” on all the money I made from babysitting/housesitting. This means that he gave me $775 of his money, and all of my earned money went into the Roth IRA, which is totally legal because I truly earned money by doing real work and because he is allowed to give up to $14,000 per year to anybody he wants without tax consequences.
# 2 My 4 Types of Income
I learned that I have four types of income: Wages, Business Income, Ordinary Dividends, and Qualified Dividends. I have wages that I make as an employee of The White Coat Investor, LLC. I have the money I make from babysitting, which my dad says is business income. I also have the dividends that I got from the mutual funds in my 20s fund. Some of those are ordinary and some are qualified.
# 3 Qualified Dividends
Before doing my own taxes, I basically didn’t know anything about dividends. There are two kinds of dividends, qualified and ordinary. Qualified dividends “qualify” with the IRS for a lower tax rate. Ordinary dividends get taxed at your “ordinary” tax rate.”
# 4 Low Income People Don't Pay Tax on Qualified Dividends
I didn’t have to pay taxes on my Qualified Dividends because I don’t make enough money yet. As a single person like me, you have to make $37,650 before you have to pay taxes on qualified dividends and long-term capital gains. However, we did have to report them. If I had made more than $37,650, I would have had to pay a 15% tax on the $204 I made in qualified dividends.
2016 LTCGs and Qualified Dividends Tax Brackets
# 5 Self-Employed Income Comes From Schedule C
I learned that Schedule C (or in my case, Schedule C-EZ) of Form 1040 is where you put down your business information, including your revenue and expenses. My revenue this year was $775 and I didn’t have any expenses.
# 6 The Taxes I Had To Pay
One of the things that I learned by doing my taxes was that there is a certain amount of money you can make in your business before you have to pay payroll taxes. That amount is $432. If you make $433 you have to pay $61 in payroll taxes. [Try calculating the marginal tax rate on that one-ed] Last year I made $335 dollars from babysitting, so I didn’t have to pay income taxes or payroll taxes. Not the case this year. In fact, I ended up having to pay $110 in payroll taxes alone on my $775! At least I got to take a $55 deduction for it on line 27!
# 7 No Payroll Taxes on Child Employees
The largest source of income I have is my wages, or employee income. In 2016, I was an employee of The White Coat Investor, LLC and I was paid $1,500 for modeling, as you can see in that great picture below. But I don’t make enough as an employee to pay taxes on that money. You actually have to earn more than $6300 before you have to start paying income taxes. My dad says the best part is that he doesn't have to pay payroll taxes for me or my siblings, since the business is 100% owned by our parents. So the money I am paid isn't taxable to the business, isn't taxable to me, will grow tax-free in my Roth IRA, and will come out to be spent decades from now tax-free!
# 8 Roth IRAs and 529 Earnings Are Tax-Free
My retirement account and education account are special accounts that the government allows to grow tax-free. In my 529 I made $3,025 in 2016 in market gains and dividends. My Roth IRA earned $190.33. But I don't have to pay taxes on any of that, as long as I only use the money for education and retirement.
# 9 Roth IRA Penalties
I also learned that you can’t take money out of your Roth IRA until you’re 59 ½ without paying a 10% penalty on it. The penalty is because the money is meant for your retirement. I don’t know why it’s 59 ½; my dad just said that it’s that way because the IRS said so, but that there are a lot of exceptions.
# 10 Dependents May Not Get to Take the Full Standard Deduction
I am dependent on my parents, since they give me food and let me live in their house. The standard deduction for a single person who is not a dependent is $6,300, but the standard deduction for a dependent is their earned income plus $350 with a minimum of $1,050. My standard deduction was $1500 (wages) + $775 (business income) – 55 (deduction) + $350 = $2,570.
# 11 I Don't Pay Income Taxes
Luckily, $2,570 is more than my Adjusted Gross Income of $2,070, so I didn’t have to pay any federal income taxes on any of my income. It isn't “taxable income.” My dad says that's not unusual, 47% of American taxpayers don't have to pay federal income taxes on their income. He also says if I ever decide to run for office, I shouldn't tell people that. They don't like to hear it, even though it's true, and it'll make me lose the election. But, like most people who earn money, I do have to pay payroll taxes- $110 this year. (See # 6 above.)
Whitney prepares to mail her taxes for the first time
# 12 Deductions Don't Cover Payroll Taxes
I also learned that deductions can't be applied to payroll taxes, which is why I had to pay taxes this year. As you can see, payroll (self-employment) taxes are added back in below the standard deduction. Luckily, my dad was nice enough to pay the $110 for me. 🙂
Thanks for reading my post and watch for a new one next quarter.
What do you think? Have you ever prepared a tax return for one of your dependents? What did you learn? Was there anything in this post that was new to you? What ways have you figured out to legally pay your children? Comment below!
Simply Amazing Post Whitney. I am a 44 yr cardiologist and have never done my taxes on my own. Your post has motivated me to give it a try. Also i have started some money saving tips with my daughter. She is 7 yrs old. I am planning to employ her in my small LLC. What age do you think is good for her to start thinking about her taxes?
Also i have become a close follower of WCI and recommending it to my other colleagues.
Absolutely delightful post Whitney. Sounds like a great experience and you should have your dad let you write for the site more often. Keep up the good work!
Jim/Whitney: Is the -399 capital loss on line 13 from tax loss harvesting in the “20s fund”? If so, wouldn’t it make more sense to carry this loss forward to another year when Whitney makes more money (more than the standard deduction) and actually owes income tax? Seems like it got wasted this year.
Yes, that’s what it is from and yes it makes sense to carry it forward.
No, it didn’t get wasted this year nor has it in any year since 2008 when the loss occurred. That’s why it keep showing up on the taxes. It will be carried forward again to next year since it wasn’t used (she owed no income tax.) You can’t apply it to payroll taxes.
Good to know. Thanks for the response.
What a great post Whitney! I am so impressed that you are doing your own taxes and wish I were brave enough to do the same. What you are learning about finances now will be invaluable to you in the future. Great job! It also sounds like you are already well on your way to financial independence…really, really cool. Thanks for your post.
(I’m also appalled that our government took $110 of your hard earned dollars in payroll taxes but glad your dad was kind enough to pay them for you.)
Loved this post!
It was very helpful….Well done.
Being redundant I see no good reason to do your own taxes; who will you call when there are issues or an audit
INVESTING on your own-that’s too easy to do and learn
Why would you need to call someone if you understand how taxes work? You can resolve the issues and/or go to the audit yourself. Or if you don’t want to, you can hire a tax attorney at that time. Certainly not a good argument to hire a tax preparer. Now if you want to save yourself the time or you have a particularly complicated situation, then sure, go hire a tax preparer.
I had a complicated situation (self-employment, limited partnerships, K1’s, real estate) and still did it myself w/ a good tax program. I kept a tax preparer on retainer at first, and could call w/ questions. But after a year of so, I could do it alone. Never got an IRS letter after I started myself (I did once when I used a preparer) The hardest part of doing it yourself is learning the lingo and where to put what. Now, I enjoy taxes; it’s like a true-to-life computer game for me; playing w/ real money. I use the H+R Block program, but Turbotax is a bit clearer. Now that I’m retired, it’s a “piece ‘o cake”.
A scant number of docs actually understand how to invest; no less how the tax system works
Maybe hiring a good cpa might lead them in a better investing direction seeing their foolish investments
Really think its preposterous for 99% of hi income professionals; just my opinion and I am sure I could learn it but the risk to me is greater than saving a few bucks
after all if you are a salaried doc with no outside businesses and a non trader of stocks/bonds, a return is not a hi cost item in your budget
worse is screwing it up and getting audited!!!!
If you’re a salaried doc your return is probably really easy, difficult to screw up, and low risk for an audit.
Great article, Whitney! I hope my daughter grows up to be as mature and hard-working as you.
Everyone here should have their teenagers have earned income and open a Roth Ira
Whitney is off to a good start
Surely all the children will be in the business
They’re all in it now, but we’ll see how much interest they have in really getting into it as they get older.
Great post Whitney! You are a very impressive 12 year old, keep up the strong work ethic. I think you should ask you employer for a raise, you do such a great job of modeling!
I’d give her a raise if I thought I could justify it to the IRS. My incentive is to pay her as much as I possibly can.
Great work!
Had to share this post 🙂
I wonder what the going rate is for 12-year old writers 🙂
Is there some reason to pay them less because they’re 12? I couldn’t think of one.
Whitney should absolutely get whatever the going rate WCI pays for guest posts. Her age is a feature, not a bug: she is providing your readers with the Subject Matter Expert perspective of a 12-year-old on money. As can be seen by the comments, this is something that is of value to your readers!
Also: Whitney, nice to see you taking control of your finances in such a cogent manner!
I pay her way more than the going rate for guest posts ($0) because she writes a regular column. 🙂 I agree that there is great value in her columns for regular readers, their children, the columnist herself, and me.
Great Job Whitney! I do think blog writers should get paid also! My girl is 8 so she doesn’t babysit yet, but I am saving your post so she can learn from it when she starts!
Truly inspiring. Keep up the great work!
Why not open a Roth Individual 401k with Charles Schwab?
According to their website, the minimum opening deposit is “$0”.
Contributing to a Roth Individual 401k would not decrease the amount she could contribute to her Roth IRA because it would not decrease her earned income.
Once you build up the Schwab Roth Individual 401k to over $1k, you could transfer it over to a Vanguard Roth Individual 401k as I believe the minimum to open a Vanguard fund is $1k for a Target Retirement Fund.
Bill
Seems a lot of hassle to open a Roth individual 401(k) when you don’t have enough income to max out a Roth IRA, no? Every dollar of earned income is going into the Roth IRA now.
When I first looked at this, I thought that she would be able to put an additional $775 of self employment babysitting income into an additional Roth retirement account, a Roth Individual 401k.
This would be in addition to the $2,275 ($1,500 W2 income & $775 self employment income) she put into her Roth IRA. So she could put a total of $3,050 ($775 in her Roth Individual 401k & $2,275 in her Roth IRA).
Contributing to a Roth IRA or Roth Individual 401k has no impact in reducing earned income, so contributing to one Roth retirement account has no impact on contributing to the other Roth retirement account, as long as you have self employment income to fund the Roth Individual 401k.
If she funded her Roth Individual 401k every year with self employment babysitting money, that could be quite a sum in 50-55 years when she takes it out state & Federal tax free.
Then last night I thought, why isn’t she an independent contractor for White Coat Investor & paid for each article she writes & each photo shoot she does in conjunction with each article?
She would have to pay self employment tax (SE, employer & employee contribution of SS & Medicare), but if she was an independent contractor she could contribute $2,275- 1/2 SE tax to her Roth Individual 401k & $2,275- 1//2 SE tax to her Roth IRA, for a total contribution of about $4,000 (after 1/2 SE tax reduction) to her Roth retirement accounts instead of $2,275 to her Roth IRA only. I didn’t do the exact number to reduce the SE tax from her independent contractor income, but hopefully you get the idea.
I realize it may be a hassle to open up a Roth Individual 401k & she would have to pay SE tax as an independent contractor, but just think what funding her Roth Individual 401k for 10 years, in addition to her Roth IRA, would be worth with tax free compounding & tax free withdrawals 50 years from now.
Bill
You’re thinking through all the right questions. The reason she isn’t an independent contractor is because this way neither she nor I pay SS or Medicare taxes on her WCI wages.
I don’t think you can contribute the same earned dollars to a Roth IRA that you contribute to a Roth 401(k). I can’t cite chapter and verse in the code why not, but it certainly violates the spirit of the tax code. I’d love to be proven wrong. But even so, not sure I’d do it due to the hassle and additional tax.
Thank you for sharing your experience, Whitney! WCI, could you tell me more about the IRA itself–who it’s through and why you chose that? Thank you!
Whitney just left for camp this morning, but that’s actually the subject of her next post.
Not the next one, the one after that 🙂
As a financial advisor and someone who reads way too many articles on finance, I have to say this is my favorite one that I’ve read in a while. Whitney, you did an incredible job both learning so much and writing about your experience to benefit others! As a father of two little girls under two, and someone who has already thought about at length how to start teaching them about finances from a young age, this definitely gave me some fun ideas and inspiration. So thanks for your article and all those parents out there who I’m sure you’ve shown it’s never too early to start teaching important money concepts!
Great write up that I will share with my kids Whitney. I started paying them this summer and have been putting the money into their investment accounts. Maybe they should put it in a Roth and do their taxes 😉
Thanks,
DFG
The best part about putting money into a Roth for the kids is the timeframe. It’s fun putting numbers into a retirement calculator and projecting out 50-60 years in the future. Everyone gets to retire with multiple gadzillions in assets after funding their Roth for a decade followed by five decades of compounding.
Oh, this is nice that the kid can do a tax return. As long as mom & dad are not in the doctor’s income bracket. Because, if so, the poor child would be subject to the Kiddie Tax. For those not understanding, our fair government has determined that too many high earners (like doctors) have been cheating the system by shifting income to their kids. To prevent this, Congress passed some laws that require children to pay taxes at the same RATE as their parents, once the parents reach a certain high level of income. So, bye-bye to that tax-free qualified dividend. So long to that 10% tax bracket. And worst of all–no way a 12-year-old can do her own tax return easily! Sad! 🙁
On the plus side, Whitney overpaid her taxes because as a minor (under the age of 18) doing household-type work (babysitting, housecleaning, etc), Whitney is EXEMPT from the self-employment tax! She does NOT have to pay this and her employer does not have to pay it either when her annual earnings from this type of activity is under $2,000.
So, it’s easy to misinterpret the law by even experienced financial folks. Just remember, consult your tax pro for tips that will save you more than the fee you pay!
Interesting idea that Whitney would be the household employee of the half dozen households she babysits for rather than self-employed. After reviewing the IRS literature, I think you’re probably right, but there are an awful lot of people confused about this on the internet. Now she gets to learn how to file a 1040X to get her $110 bucks back and gets another column out of it, for which she can be paid even more tax free money, saving me another $140 in tax or so! Which will grow to more than $1000 by the time she spends it since it can go into a Roth IRA.
But the kiddie tax? That applies to unearned income. We’re talking about earned income here. Whitney has some unearned income, but not nearly enough to trigger the kiddie tax.
Not sure why you think a 12 year can’t do a simple tax return with a little parental guidance. This idea that the tax code is too complicated for non-professionals to understand is a bunch of bunk. I see tax pros make plenty of mistakes on returns and give plenty of bad advice. Simplifying it would do wonders for everyone involved. If someone needs help, hire help. But use the professional to teach you, not just to do it for you.
My comment is more aimed at your general doctor-reader customer. The point I am trying to make is that taxes can become (unnecessarily) complex for the high-earners AND their offspring and that, while the readers may be quite well-educated, we tax pros are here to ensure the BEST outcome for the clients. A patient COULD pull his child’s teeth with a pair of household pliers, BUT a good dentist probably has a better fix than just removal of the tooth. Professionals exist in both the medical and financial field not for the purpose of just earning money, but for the higher purpose of helping those with their “pains” in an efficient manner.
You pointed out well that there are simple ways that high-earners can defer income and reduce tax. I agree, but a session with a good pro-active tax planner is like a good annual check-up with the doc or dentist! And the money spent on a plan is worth its weight in gold saved from the guvmint!
Weird how every professional wants to compare themselves to a doctor. “We’re like the doctor for your…..” I get a kick out of it.
At any rate, it’s a bit of a conundrum. The high income earner has to weigh the pros and cons of hiring help.
Pros- You can learn less, it may free up some time, you may end up with a good tax pro instead of just some random tax preparer, and perhaps you come out ahead after fees.
Cons- You may end up with a lousy tax pro, you will certainly be out the fees, you are less likely to learn this stuff yourself, and you may not come out ahead after the costs, especially if that tax pro isn’t a proactive tax planner as discussed in your comment (you know as well as I do that most tax pros are all retroactive.)
I’m truly disappointed that you don’t think I could do my own taxes. (They’re not very complicated when you’re my age) But thanks for the comment on the household employees part. Went in and changed that today with a 1040X. So you can read my next post about that soon. 🙂
P. S.- You have to have a tough skin to be on the internet so you don’t bother me.
Whitney, Doc of Tax didn’t say you couldn’t do your own taxes. He/she pointed out you can’t do them *easily* (due to the complex nature that Congress has made taxes in general). No thick skin needed; I’m just glad you were able to get your $110 back, thanks to the eagle eyed readers here at WCI.
I DO think it’s great you can do your own taxes. I pointed out that for high-earners (or high-earning parents), there are indeed complexities that not only you might miss, but also that the parent might miss as well!
Today’s tax software helps a lot, but NONE of the packages today do a good job at tax planning—they only help you (and your parents) report the history of your finances LAST year! That’s why it is still valuable to visit a tax planner, not just a tax preparer.
Do, and you will understand.
Do it a LOT and you will know what you didn’t know that you didn’t know!
True, my taxes weren’t very complex
Absolutely I agree the bang for your buck is in the planning for next year, whether done yourself or with the aid of a GOOD tax pro.
I truly wish finding a qualified tax planner was only a Google search away. If you’re completely ignorant about taxes, you’re pretty likely going to end up with someone only vaguely competent. How would anyone know the difference until you met someone more talented?
The reality is effectively vetting any professional takes a bunch of time and some degree of knowledge. I haven’t done my own taxes in years, but have changed tax planners several times. Investing in real estate meant finding a real estate savvy tax person. Same thing with raising funds and investing in startups. And that’s all before getting into their personal take on the endless grey areas of tax law.
Any thoughts on finding the right tax planner?
I agree with you it is far harder than one would think and you can’t just walk into the local H&R block and expect something good to result.
Referrals from someone with a similar tax situation might be a good place to start, but asking the right questions in the initial encounter would be wise too (how many real estate investor returns do you do each year?)
This is a genius idea! This is reason enough to have a side hustle that your kids can work on. What a great way to not only get your kids the knowledge they need to transition into adulthood, but also to help them get a head start on life. I’m going to start looking for an opportunity I can get my kids to work on, for example my son is very musically gifted and I think I could pay him to create some intro music for a podcast.
Thanks for getting my creative finance juices flowing!
What a terrific post. I’m bookmarking it for when my son is old enough to contribute some content to the blog. Some great tax and parenting lessons here. Whitney, your writing is very impressive,please keep it up.
Great article Whitney! 3 follow up questions for WCI:
1) Did your family business issue Whitney an actual W-2 for the $1500 reported on her 1040?
2) If a W-2 was issued, was your business required to file and pay FUTA and SUTA for the $1500
3) Was Whitney paid either by the hour (modeling income) or by modeling session? (if the latter, then that compensation would seem to make Whitney to be considered to be an independent contractor….not household help……and thus FICA would be due on her net profit ($1500) and reported on Schedule C
My reason for asking is that my son, who has a book business, paid his 14 year old not by the hour and instead on a “commission basis” and is trying to decide how to report the income (roughly $1000) on the child’s 1040 (so, the child, like Whitney, can open and fund a Roth IRA.
Thanks!
Yes. The business issues W-2s and a W-3 for all of its employees in accordance with law.
No FUTA/SUTA was due for these minor employees of a non-incorporated business owned completely by their parents.
Hourly.
You mean WCI is a sole proprietorship? Did you not have any concerns re the liablities? Especially the risk to your personal assets?
I’m pretty sure I didn’t say that.
The business structure of “WCI” has changed multiple times over the years and is fairly complex now actually. The business that employs the kids is indeed a sole proprietorship owned by me. And it has zero liability. You probably would not consider the business that employs the kids to be “WCI”.
WCI:
Wow! Thank you for your “instant reply”……and for the clarification.
Since my son did not pay his child by the hour; but, instead paid his child as “an independent contractor” by commission, then is it safe to believe that my son is required to issue a Form 1099-Misc for the total paid to his child and have his child report that income on Schedule C?
Thanks!
Yes and yes. And the child will owe payroll taxes. That was not a good way to do it. Is there some reason your son can’t go back and make it an hourly rate and make a time sheet to show the IRS in the event of an audit?
I will suggest to my son that for 2019, he keep time sheets and pay by the hour and issue the W-2 and W-3; but, for last year, the price of paying $150 in FICA taxes per $1000 of pay seems to me to be a small price to pay when considering that a $1000 one time Roth IRA contribution for a 14 year old growing at a compound rate of 10% per year would be worth $129,130 at age 65. Also, I do plan to help my 14 grandchild prepare the 2018 Federal and state tax returns (like Whitney) and that will be also a “teachable moment” when the grandchild sees that FICA taxes are due (paid by me) as well as how much a single $1000 contribution can reasonably be expected to grow to.
Follow up questions:
My son also pays the 14 year old to do lawn care jobs…..mowing, blowing, etc and babysitting a young sibling on occasion.
1) Can these family (as opposed to his business) paid jobs be reported as income on the 14 year old’s 1040 and if so,
2) how would the “paperwork” be done to satisfy the IRS and so that the income is reported as “wages” not subject to FICA? I am assuming that if the total amount paid to the 14 year old is under $2000 that a W-2 (and W-3) would not have to filled out.
WCI: Thank you for creating your blog and for all the incredible amount of time and effort you put in to help others.
1. No. Definitely not. But you can pay the neighbor’s kid and he can pay yours.
2. You need to do all the required paperwork for employees, including that they’re in the country legally. I don’t know why you think you wouldn’t have to fill out a W-2 for $1,999. I don’t recall ever seeing that rule. (I could be wrong though, but please cite a reliable source.)
WCI,
I think (my) confusion came from whether or not my son can treat his 14 year old as a “Household employee” which you wrote is not possible.
https://www.irs.gov/publications/p926#en_US_2019_publink100086752
above is a link to IRS pub 926 for the year 2019; and below is language that seems to indicate (to me) that a W-2 is only required if the household employee earned $2100 for the year 2019 (I believe that for 2018, the threshold figure was $2000):
Form W-2.
File a separate 2019 Form W-2 for each household employee to whom you pay either of the following wages during the year.
Social security and Medicare wages of $2,100 or more.
Wages from which you withhold federal income tax.
You must complete Form W-2 and give Copies B, C, and 2 to your employee by January 31, 2020. You must also send Copy A of Form W-2 with Form W-3, Transmittal of Wage and Tax Statements, to the SSA by January 31, 2020. We encourage you to file Form W-2 electronically. Electronic filing is available to all employers and is free, fast, and secure. Visit the SSA’s Employer W-2 Filing Instructions & Information website at SSA.gov/employer for guidelines on filing electronically. If filing electronically via the SSA’s W-2 Online service, the SSA will generate Form W-3 data from the electronic submission of Form(s) W-2; no separate Form W-3 is required.
If you’re not required to file a Form W-2, we encourage you to provide your household employee with a receipt for services that includes the dates worked, wages paid, and a general description of work completed. This receipt will help the household employee to report his or her wages on Form 1040.
Hope that this IRS language from Pub 926 clarifies the $2000 figure that I wrote in an earlier post.
If not a household employee, then it is my understanding (like yours) is that for a business (such as yours), there is no minimum amount for creating a W-2 for each employee.
I think trying to hire your minor child as a household employee is a big audit red flag and probably not going to pass the audit. Either have your business hire your kid or don’t do it at all. Chores are not salaried.
What if rather than by earned income on a W2 a minor child was paid as a self-employed contractor? Obviously that’d make the minimum income to file much lower. Were the babysitting/housesitting services provided that brought in Whitney’s $775 that year done outside the WCI household?
If I need lawn services but happen to have an able-bodied teenager, whether I contract with him or the guy that does my neighbor’s lawn seems like a moot point. Or maybe referring to “chores” in the “keep your room picked up and load the dishwasher” sense of the word?
The contractor will owe payroll taxes. The minor employee of a business owned entirely by her parents (that isn’t a corporation) will not.
Yes.
It might be a moot point to you, but the IRS will care. Can’t pay for chores. You can pay your neighbor’s kid though and he can pay yours.