Micro Business for Teens: Taxes and Lessons Learned

February 27, 2012 by  Filed under: Taxes 

A micro business (a small, one-person business) is a great way for a teenager to earn some cash and learn business skills. A teenager can learn about customer service, responsibility, record keeping, and even math and writing, all while earning money on his or her own. If a micro business is successful, a teenager will also learn about paying taxes.

“My teenage daughter, Julie, made money from her micro business teaching piano lessons. Does she owe taxes?” a mother recently asked.

Whether Julie owes taxes depends on how much money she made, what she offered to sell, and where Julie worked. There are several types of taxes a micro business owner might owe.

Types of Taxes to Pay:

Federal Income Tax: If a student earns more than $5,700 (in 2011) in profit from a micro business, he or she will owe federal income tax.

Self-Employment Tax: Self-employment tax is the same as Social Security and Medicare for self-employed people, including teenagers with a micro business, and it is approximately 15% of the profit over $400. If Julie had profit of over $400 from her business, she will owe self- employment tax. Many teens who have profit from a business find that they may not owe federal income tax, but do owe self-employment tax. That was the case for Julie.

State and Local Income Taxes: Some states offer tax exemptions for students under age 18, so check with your state laws. Additionally, the thresholds of when income becomes taxable varies by state. For example, in my home state of Ohio, a teenager can earn up to about $2,000 before owing Ohio income tax.

Sales Tax: There may be sales tax to collect from customers and pay to the state if a student is selling a product to the final user. Julie sold services – piano lessons – which are not subject to sales tax in her state.

How to Reduce Taxes:

The best way to reduce your taxes is to keep good records and take every legal deduction you are allowed, such as mileage, advertising expenses, etc. Another way for a teenage micro business owner to reduce some of his or her tax burden is to consider being a household employee.

Household Employees

A teenager can avoid paying the self-employment tax by working as a household employee. A household employee is a housekeeper, maid, baby-sitter, or gardener, who works in or around a private residence.

Household employees under the age of 18 are not considered self-employed business owners for tax purposes and so they do not pay self-employment tax. This is a huge tax benefit for teenagers. It immediately gives them a 15% pay raise (15% is the rate of the self-employment tax). Lawn mowing and babysitting have long been great ways for teenagers to earn money and now you know why – no self-employment taxes to pay! Julie did not work as a household employee, so she did not benefit from its tax-free status. For more information on household employees, visit the Internal Revenue Service website and search on “household employee.”

The self-employment tax may be a surprise to teenage micro business owners. Many teenagers do not realize this extra tax burden when they start a micro business. This should not discourage a teenager from starting a business; it is just another responsibility to be aware of.

In the end, Julie determine that she owed self-employment tax, but not federal or state income tax, nor sales tax. Julie learned some great lessons in civic responsibilities, law, record keeping, and even math after her tax responsibilities were explained to her.

Carol Topp, CPA (MicroBusinessForTeens.com) is an accountant and author of the Micro Business for Teens book series. Her goal is to make taxes and accounting easy to understand through her website and books. Visit http://www.MicroBusinessForTeens.com for micro business ideas and tips.

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