Does Your Teen Need to File a Tax Return?

Dear Carrie,

My daughter is 16 and has her first paying job as well as stock dividends and capital gains from a small investment account. Does she need to file a separate tax return?

—A Reader

Dear Reader,

Congratulations to your daughter—and to you. A first job and exposure to the stock market are both big steps toward financial independence and personal responsibility. And of course, learning about taxes is another part of everyone’s financial education.

So let’s take a look at when a teen needs to—or should—file their own return. Then I'll get into ways you can help your daughter learn to manage her money wisely—which, to me, is the most important lesson of all.

Basic guidelines for filing a teen's tax return

There are three factors that determine whether your daughter needs to file a separate tax return. First, look at the IRS criteria for being a dependent.

• She must be under 19, or under age 24 and a full-time student, or permanently disabled at any age;
• She must live with you more than 50% of the year (if she’s not a full-time student); and
• She can’t provide more than half of her own financial support.

Second, look at her income. Here's where it gets more complicated because there are different rules for earned income from a job, unearned or investment income from dividends, interest or investment gains—or a combination of both.

And third, she will need to file her own return if her earned or unearned income exceeds certain thresholds.

For earned income only

This is pretty straightforward. A dependent who only has earned income only has to file a separate tax return if their earned income is above the standard deduction—$12,550 for 2021. If your daughter earned less than that, she doesn’t have to file.

That said, it could be a good idea to do it anyway because if her employer withheld federal income tax, she might be entitled to a refund. You don't want her to miss out on that!

For unearned income only

Unearned income has different rules. If a dependent has unearned income above $1,100 for 2021, a tax return is required. But when dealing with unearned income only, you may be able to include that income on your own return. One caveat: If you include it on your return, it could boost you into a higher tax bracket—and possibly higher tax rates.

For a combination of both

The rules change again if a dependent has both earned and unearned income, as is the case for your daughter. In this case, you need to file a separate return if:

1. Her unearned income is more than $1,100.
2. Her earned income is more than $12,550.
3. Her combined income totals more than the larger of $1,100 or earned income (up to $12,200) plus $350.

As an example, let's say your daughter had $100 in investment income plus $4,000 in earned income. She wouldn't have to file a return because both her unearned and earned incomes are below the individual thresholds and her combined income of $4,100 is less than her total earned income plus $350 ($4,350). However, if the balance tips to more investment income, and she had even $400 in investment income, she would have to file because her total income of $4,400 would be more than $4,350.

Now let's say your daughter had only $400 in earned income but $800 in investment income. In this case, she would also have to file a return because her total income of $1,200 is more than $1,100.

All this can be very confusing, so unless your daughter's situation is straightforward, I'd talk to your tax professional. Also check out IRS Publication 501 for a thorough treatment and worksheet.

W2 versus 1099 income

You also should be aware of the different treatment of income reported on Forms W2 and 1099. If your daughter is considered an employee, her income will be reported on a W2 and subject to withholding. However, some employers hire part-time workers as contractors. On the plus side, nothing will be withheld. On the minus side, contractors who have net earnings (income minus expenses) of more than $400 will owe self-employment taxes, which basically cover Social Security and Medicare taxes. In this case, a contractor has to file a tax return even if no income taxes are owed.

A word on the “Kiddie Tax”

You may have heard of the Kiddie Tax, so I think that's also worth a mention. This has to do with tax rates on unearned income.

While for 2021, there's no tax on a child's unearned income that is less than $1,100, tax rates on unearned income above that amount vary. Unearned income between $1,100 and $2,200 is taxed at the child's rate. Unearned income above $2,200 is taxed at the parent's highest income tax rate. If your child has a lot of unearned income, that could be pretty significant. (These figures have increased by $100 for 2022.)

Going beyond taxes

Whether or not your daughter files a return, I'd definitely talk to her about taxes and withholding, and have her work with you as you prepare either hers or your own return.

Then take it beyond taxes and talk about investing basics as well as responsible money management. As you review your daughter’s stock gains or losses, you can start to talk about the importance of having a diversified portfolio and a long-term perspective. And now that she is earning her own money, help her create a budget so she can make the most of it. For instance, what do you expect her to pay for? Clothes? Entertainment? Gas? Have her keep track of her expenses monthly (an online budget calculator can help).

It can also be great to encourage her to save a certain percentage of her paycheck each month for a future goal. If she hasn't done so already, help her open both checking and savings accounts and set up an automatic deposit from one to the other. Now that she has earned income, you might even help her open a Roth IRA (a Roth can be especially powerful for someone like a child who is currently in a low tax bracket but likely to be in a much higher bracket later).

Establishing good money habits early is incredibly important. Unfortunately, though, not enough kids learn much about managing money in school, so it's largely up to you. Show her how you manage for both the short- and long-term. If you take it step by step and include her where appropriate in your own money strategies, you'll set her on the path to being able to not only handle her taxes, but her financial future, as well.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.