TAX NEWS - 2010

Roth IRA: Consider Roth IRA for young workers

Q: My son who is 15 years old is working part-time this summer. I'm anticipating he will earn about $3,000 over the summer. He does not work during the school year. Can he open a Roth IRA and contribute the full $5,000? Will he have to file a tax return next year?


A: Yes, your son is eligible for a Roth IRA. The fact that he is working and has earned income (income from one's labor) qualifies him for an IRA.

I love that fact you are considering a Roth IRA. In your son's situation a Roth IRA is, hands down, so much better than a traditional IRA. The main benefit is the money invested will grow tax-free. When he eventually retires and withdraws money from his Roth IRA there will be no income taxes that need to be paid. If he went with a traditional IRA the money would be subject to a substantial tax liability.

The maximum amount he can contribute is $5,000. However, in order to qualify for the full $5,000 contribution, he must have earned income of at least that amount. If your son earns $3,000 — that would be his maximum contribution. In other words, to contribute the maximum $5,000 into a Roth IRA you must have a minimum of $5,000 of earned income.

With regards to filing a tax return, considering that your son's salary is his only source of income, he could earn up to $5,700 in 2010 and not be required to file a tax return. However, that doesn't mean he should not. The reason is he may be entitled to a tax refund. His employer will be withholding federal and state income taxes from your son's wages. The only way to get that money back is to file a return.

I am frequently asked if there are any tax breaks available if a child works in a family business. In fact, there is a tax break that some small business owners may qualify for. First, there has to be a business. In other words, you can't play shenanigans by setting up a business just to receive some tax breaks. There must be a viable on-going business. In addition, the compensation that the business pays your child must be a reasonable wage for work the child performs. In addition, your business must be either a sole proprietorship or a partnership that you and your spouse operate.

If you meet these qualifications and your child is under the age of 18, the tax break is that you don't have to pay Social Security taxes, Medicare taxes or federal unemployment taxes on your child's wages. Not only does your child save by not having money withheld from his wages but the business saves in that it does not have to match the contribution.

The tax breaks should not be a motivator in hiring a child. Obviously, the benefits of learning to work and being in a work environment are invaluable to a child and can pay dividends into the future.