DD Internship - Taxes, 401(k), Support Test, Jump Start

[clobber]

Full-time student and my dependent DD has lined up an internship for the summer. I figure someone here has been through these issues. Found some tidbits in other threads but would like to hear your thoughts:

1) Standard deduction (single) for 2021 is $12250. DD expects to make between $10k and $15k depending on how many weeks are worked - which is flexible and won't be determined until near the end. I think she should claim exempt on her W-4 until she has made ~12k and then file a new W4?

2) There is an additional relocation allowance lump sum that is "tax assisted." As I understand it, this means the "gross up" amounts will be reported as wages on her W-2. The company states that they withhold a flat 22% that is sent to IRS. This appears to be independent of your actual tax bracket. This means that she will probably want to file a tax return even if she makes less than the $12250 required to file. Right?

3) The company has % matching for 401k contributions. The overall number for a multiweek internship is not all that much (~$400). Is there any downside to participating? I figure it is "free" money and can probably be rolled over into future employer retirement accounts.

4) DD is excited to save money for retirement. Lets just call that good parenting. I have the means to assist and see few possibilities. First, gift her $6k for her Roth IRA. Second, gift her up to her earned income to contribute to company Roth 401(k). Third, a combination of the two. Any pros and cons to the choices?

Thoughts? Any other considersations?

 

[SevenUp]

Your ideas look good!

Some specific answers:
1. Yes, that should work. Another approach would be to look at the tax that will be withheld on the relocation allowance and compare that to her expected tax liability if she gets the full $15K pay. If the relo withholding will cover enough, put a large amount on line 3 of the W-4 so no withholding on the regular pay occurs. A little extra work up front, but only one W-4 needed.

2. Yes

3. No

4. All pros.

 

[Jerry1]

Re: #1, The withholding. If you don’t mind writing a check, she could not have anything withheld. There would be no penalty or interest under the safe harbor rules - especially at that level of income.

Not sure of the W-4 rules, but she might not be able to say she’s “exempt”. Check the wording on the form.

 

[SecondCor521]

1. Three things:

(a) The standard deduction for singles in 2021 will be $12,550, not $12,250.

(b) If your daughter will be your dependent in 2021, the IRS instructions indicate that she needs to complete the Standard Deduction Worksheet to determine her standard deduction amount. Generally this will be the lesser of $12,250 or her earned income plus $350. See the Form 1040 instructions for the standard deduction and the worksheet, and note "Exception 1" in particular.

(c) She can legitimately only claim exempt on her W-4 if she qualifies, which would require her to have had no tax liability in 2020 and to expect to have no tax liability in 2021. Doesn't sound to me like that quite fits. She might not have tax liability in 2021, but that's not quite the same thing as expecting no tax liability. I think it's better just to fill out the W-4 as accurately as possible and only do it once, but YMMV. (Depending on the size of the relo bonus and the rest of her tax situation, her federal tax bill will only be a few hundred dollars anyway, and if the W-4 is accurate her withholding should only be a few hundred dollars, and so any excess withholding is not likely to be much either. The opportunity cost on the IRS having a few hundred dollars of her money between this summer and next February/March is approximately pretty much zero.)

But you can, if you want, try to figure in the relo bonus tax assistance, because that 22% withholding will probably be more than adequate to cover her tax liability on the bonus and will probably cover a significant portion of her tax liability on her $12K to $15K of regular income.

2. Probably. The first step is to see if she's required to file. Assuming her income is low enough and she doesn't meet any of the other requirements to file (See charts B and C in the Form 1040 instructions), then she has to decide if she wants to file. One good reason to want to file even if you don't have to is to get back excess withholding. If she properly fills out the W-4 and gets a grossed-up relocation bonus, she'll probably have excess withheld.

3. Only reason I can think of would be hassle factor, but for most people $400 would be worth the hassle. Depending on the circumstances, she might be able to roll over the 401(k) into her own IRA.

If she's in a low tax bracket this year (sounds like she would be), it'd probably be smart to do a Roth 401(k) (or possibly an after-tax 401(k)) and then roll it into her Roth IRA. Whether this would work would depend on whether the employer offers a Roth 401(k) (or after-tax 401(k)) option.

It's also probably just a good idea to get her in the habit of starting 401(k) contributions at her job as soon as possible, which it sounds like you'd do anyway but that's a point in favor of putting up with a bit of hassle in addition to the actual $400.

4. Congrats on being in a position to help and wanting to encourage retirement contributions!

You can gift your daughter up to $15K per year without filling out forms or paying any gift tax. If you give her more than $15K per year, then you would need to file a gift tax return with the IRS.

She is eligible to contribute up to $6K to her Roth IRA (or traditional IRA, but Roth is probably better in this case) of her box 1 wages. The thing to note here is that her 401(k) contributions would reduce her box 1 wages. So if she contributed all of her salary into her 401(k), she would not have any box 1 wages to properly qualify her Roth IRA contribution.

(ETA: Note that Roth 401(k) contributions don't reduce box 1 wages - see post here: https://forum.mrmoneymustache.com/p...-to-contribute-to-roth/msg2816414/#msg2816414)

For a young person in a low tax bracket just starting out, I think the Roth IRA is a great choice. (If you do all Roth all the time then the logistics of early retirement could become a different kind of puzzle later.) So if her workplace only offers a traditional 401(k), I would prioritize the Roth then the 401(k).

Finally, only you know your daughter, but it's probably a good idea to think about whether any of your "help" is crossing boundaries or represents Economic Outpatient Care (term from Millionaire Next Door). I didn't read any of that into any part of your post, just something to be mindful of.

 

[clobber]

(a) The standard deduction for singles in 2021 will be $12,550, not $12,250.

Oops, thanks.

(b)the IRS instructions indicate that she needs to complete the Standard Deduction Worksheet to determine her standard deduction amount. Generally this will be the lesser of $12,250 or her earned income plus $350.

Thanks you for pointing this out. Can you elaborate on why this might matter in this situation? Can you elaborate on why this would matter in any situation? Not being familiar with this, it seems like it limits the tax liability for someone who is a dependent to -$350 (negative). Why? On the other hand, a person who is not a dependent could go further negative.

(c) She might not have tax liability in 2021, but that's not quite the same thing as expecting no tax liability. I think it's better just to fill out the W-4 as accurately as possible and only do it once, but YMMV.

But you can, if you want, try to figure in the relo bonus tax assistance, because that 22% withholding will probably be more than adequate to cover her tax liability on the bonus and will probably cover a significant portion of her tax liability on her $12K to $15K of regular income.

Agreed. I'm in the weeds on what could be a very small tax liability. Let's say she makes $15K including the relo. Rounding things off she will need to pay 10% on 15k-12.5k = $250. Over the course of probably 6 checks we should probably set her W4 to withhold $40 per check. If nothing else it is a lesson in how to do the W4.

2. One good reason to want to file even if you don't have to is to get back excess withholding. If she properly fills out the W-4 and gets a grossed-up relocation bonus, she'll probably have excess withheld.

Confirmed, thanks.

3. Only reason I can think of would be hassle factor, but for most people $400 would be worth the hassle.

Whether this would work would depend on whether the employer offers a Roth 401(k) (or after-tax 401(k)) option.

It's also probably just a good idea to get her in the habit of starting 401(k) contributions at her job as soon as possible

Agreed on all counts. Yes, her employer does have the Roth 401(k) option.

So your practical limit will be: Roth IRA contribution + her 401(k) contribution <= her salary plus bonus.

For a young person in a low tax bracket just starting out, I think the Roth IRA is a great choice.

Agreed again.

Finally, only you know your daughter, but it's probably a good idea to think about whether any of your "help" is crossing boundaries or represents Economic Outpatient Care (term from Millionaire Next Door). I didn't read any of that into any part of your post, just something to be mindful of.

I do wrestle some with if -or - how much to "help." However, the cold hard math says starting early is the way to go.

 

[SecondCor521]

Thanks you for pointing this out. Can you elaborate on why this might matter in this situation? Can you elaborate on why this would matter in any situation? Not being familiar with this, it seems like it limits the tax liability for someone who is a dependent to -$350 (negative). Why? On the other hand, a person who is not a dependent could go further negative.

[...snip...]

I do wrestle some with if -or - how much to "help." However, the cold hard math says starting early is the way to go.

Regarding the standard deduction calculation for dependents, it has to do with unearned income, such as dividends or capital gains. Essentially if a dependent earns, say $10K and then has some interest and dividends that are less than $350, then there's no income tax due and generally no requirement to file. You can think of the $350 as sort of an allowance by the IRS that a dependent may have some unearned income and still not have to file, so it saves paperwork and hassle for everyone involved.

I think the reason behind it is that it's a common thought that well-off parents have to shift capital gains or dividends to kids so it can be taxed at a lower rate. The $350 limit is probably there to help prevent that idea from working. (The kiddie tax rules are also in place to prevent it from working.)

...

I understand where you're coming from as I have the same situation to a lesser degree. But I think it's not always all about the math. Relationships, personalities, character development, maturity level, and more can come into play and may, in essence, override the math. But you're aware of the pitfalls and you're being thoughtful about it, and it sounds like you have a good relationship with your DD, so you'll probably end up doing well whatever you decide.

I guess the only further thought I have there is that I think a good way to give to kids is to help them accelerate reaching goals that they have already set for themselves.

So for example, my oldest has set for himself a goal of buying his first home, and I've been chipping in some to help. He's still doing most of the heavy lifting, and it's his idea. My contributions just give him a bit of a boost.

In your case, if your DD has already decided she wants to either retire early or retire wealthy, then your giving in that way makes sense. But if her heart is on grad school or a nice car or some other goal, and you're pushing retirement savings because that's what you think she'll want, I'd suggest reconsidering.

Again, I don't detect any of that in your posts - just thoughts for your consideration from someone in a similar circumstance who has also thought about it and struggles as well.

 

[pb4uski]

1. I would do zero FWT... even if she earns more than the standard deduction she would only be in the 10% tax bracket so would only owe a few hundred and most of that would be covered by the 22% withholding on her relocation allowance.

2. Yes... if her tax is $0 she would need to file a tax return to get the FWT back.

3. Only downside is the hassle of later rolling it over to an IRA. Is the 401k traditional? Do they offer a Roth 401k? If so, I would go with the Roth given her low tax bracket.

4. Yes... a good kickstart. Perhaps consider your own matching program... you'll gift her $1 or $2 for every $1 she contributes to retirement savings.

Also, while she would not qualify as a full-time student, once she is done school and working full-time she might qualify for the Retirement Savers Tax Credit when she first starts working. https://www.investopedia.com/articles/retirement/04/031704.asp

 

[RetiredAt55.5]

3) The company has % matching for 401k contributions. The overall number for a multiweek internship is not all that much (~$400). Is there any downside to participating? I figure it is "free" money and can probably be rolled over into future employer retirement accounts.

Until recently, I had a part time job and decided to participate in their 401k only because they were kicking in 2% if I did 6%. I was only adding about $500 per year.

To be honest, I didn't read through the entire 401k plan description end to end, just skimmed it.

I discovered later the plan has a yearly maintenance fee, which in effect eats into the employer match, and will continue to eat into until I roll it into something else.

Had I know this, I wouldn't have bothered.