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You might be feeling overwhelmed right now, thinking, “You want me to explain taxes to my kids while I’m buried in my own tax paperwork?” It’s understandable, but consider delaying those lessons until after April 16. It’s vital that your children grasp the basics of taxes, as failing to do so could lead them to harbor negative feelings towards paying them as adults.
Taxation is an inevitable part of life. Regardless of whether you believe your tax burden is excessive or a bargain, the saying rings true: “Death and taxes are the only certainties in life.” As such, it’s beneficial for children to learn about taxes as a fundamental aspect of adult responsibilities.
Why Teach Kids About Taxes?
It’s essential to introduce even young children to the concept of taxes. This early education can prevent what’s often referred to as “paycheck shock,” the surprise many experience when they first look at their net pay versus what they actually earned. By familiarizing them with concepts like taxation, they’ll avoid the confusion of questioning, “Who is FICO, and why am I paying them?”
Teaching Responsibility Through Chores
Encouraging children to earn money through household chores can impart valuable lessons about financial responsibility. Establish a system where they receive allowances for completing tasks around the house. Guide them on how to manage their earnings by allocating funds into different categories:
- Quick cash (or instant gratification): 30%
- Midterm savings (for shorter-term goals): 30%
- Long-term saving and investing: 30%
- Charity: 10%
By aged ten, children should be learning about the taxes deducted from their allowances, reinforcing the notion that there’s more to their earnings than the amount they receive.
A fun activity called “Who Pays for That?” can further enhance their understanding. While driving, point out various businesses and explain their funding sources, such as how a fast-food restaurant operates on customer payments, versus public services that rely on tax revenue.
Illustrating how municipal taxes fund essential services can help children appreciate their contributions as future taxpayers. For instance, you could say, “If we see a library, it’s funded by local taxes, which comes from everyone’s paycheck.” Consider designating a Family Tax Jar where children contribute a set percentage of their earnings. Use this as a family fund to finance shared outings like pizza nights, allowing them to see the direct benefits of their contributions.
In a light-hearted moment, explore extravagant dreams—like saving for a family trip to Disney—discussing how long it would take their contributions to achieve such goals.
Filing Tax Returns: What Parents Need to Know
If your child has earned income from a summer job or occasional babysitting, questions about filing a tax return may arise. It’s essential to consult with a tax professional for personalized advice, but here are some general guidelines:
A child must file a tax return if their earnings exceed $14,600 in 2024. Those earning below this threshold generally aren’t required to file, unless they had taxes withheld, in which case they could be eligible for a refund.
Children with unearned income from investments that surpass $1,300 may also need to file a return. Furthermore, if their unearned income exceeds $2,600, it may be taxed at the parent’s rate due to kiddie tax rules.
In some cases, parents have the option to include their child’s unearned income on their own tax return using Form 8814, which can simplify the filing process if the income is low enough.
Additionally, if a child earns $400 or more from self-employment, they are required to file a return and may owe self-employment taxes as well. It’s worth noting that babysitting fees, while often informal, are still taxable if they meet this threshold.
Understanding Gift Taxes
When children receive monetary gifts, they are not responsible for taxes on this income. Gift taxes generally apply to the person giving the money rather than the recipient.
For 2024, individuals can gift up to $18,000 to anyone without triggering a gift tax obligation. This limit will increase to $19,000 in 2025.
If you give more than this amount to a child, you will need to file a gift tax return using Form 709, but the recipient does not have to report the money received unless it generates taxable earnings.
Most individuals will not pay gift taxes due to a lifetime exemption set at $13.6 million in 2024 ($13.99 million in 2025).
Special Considerations for 529 Plans
Contributions to a 529 college savings account do not count toward the gift tax limit. You can contribute up to $19,000 per child annually without tax implications. There is also a provision for a five-year superfunding, allowing contributions of up to $95,000 at once but spread across five years for tax purposes. While contributions aren’t tax-deductible federally, some states do offer deductions. Withdrawals used for qualified educational expenses from a 529 plan are tax-free; however, earnings used for non-educational purposes may face income tax and a 10% penalty.
Understanding Custodial Accounts and Trusts
If custodial accounts (UGMAs or UTMAs) are established, children will be responsible for any taxes on earnings once they have access to the account. Trusts may entail specific tax obligations, depending on their structure. It’s advisable to seek guidance on these arrangements to ensure compliance with applicable tax requirements.
Additional Insights
This article reflects insights from financial advisors and does not represent the views of the editorial team. For further guidance, refer to official resources by the SEC or FINRA.
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www.kiplinger.com