[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
# 12Deductions 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!
