What your kids need to know about taxes

Taxes are no fun but are a part of life. Here are a few tips to explain taxes to your kids.

By: The Family Money Team

03.14.2022

6 minute read

Key Points

  • Explain the reason people pay taxes
  • Make the connection between taxes and essential community services
  • Review your pay stub to show how some taxes are automatically deducted
  • Teach them the various types of taxes
  • Challenge your kids to learn the process of how taxes are created
  • Encourage your kids to become informed citizens

The deadline to pay taxes is almost here! Use this time as a learning opportunity for your kids and talk about taxes. You don’t need to go into detail, it is best to keep it simple. Use everyday activities to make the discussion fun and understandable.

The next time you go shopping with your child, point out the cost of the purchase. When it's time to check out make sure to point out any difference between the cost of an item and the total paid. There is usually a difference ranging from a few cents to several dollars depending on the cost of the item and the tax rate.

Explain to your child that the extra money is a tax that is paid to the government. Taxes are mandatory sums of money people pay to the government for the support of specific facilities or services. On the ride home point out real world examples of places or organizations subsidized by tax money including: parks, roads, bridges, hospitals, schools as well as government-financed services such as the police and fire departments. It is important to keep the conversation light and simply provide your kids with examples of how your tax dollars are spent. Perhaps ask them what things they think should be subsidized by taxes.

By the time your child has reached middle school, they can understand all the different types of taxes. Beyond sales taxes, there are income taxes, property taxes, excise taxes, and estate taxes as well as many other types of tax. A good way to open the conversation is to show your children your pay stub. Review your contributions for Social Security, Medicare, federal, state, and local taxes, and explain the purpose of each tax. Here are some common tax definitions you may want to share with your teens and preteens.

Social Security tax is the tax charged on both employers and employees to fund the Social Security program in the U.S. A Social Security tax is collected in the form of a payroll tax mandated by the Federal Insurance Contributions Act that is commonly known as FICA. These taxes fund the retirement, disability, and survivor benefits that millions of Americans receive each year from the Social Security Administration.

Medicare tax,  also known as “hospital insurance tax,” is a federal employment tax that funds a portion of the Medicare Insurance Program. Medicare is federal health insurance for people age 65 or older as well as some younger people with disabilities. Like the Social Security tax, Medicare tax is automatically withdrawn from an employee’s paycheck.

U.S. federal income tax is charged by the Internal Revenue Service (IRS) on the annual earnings of people, corporations, trusts, etc. Federal income taxes apply to all forms of earnings that make up a citizen’s taxable income, including wages, salaries, commissions, bonuses, tips, investment income, and more. 

State income tax is levied by a state on any income earned in or from the state. In your state of residence, it may mean all your income earned anywhere. Like federal tax, state income tax is self-assessed, which means taxpayers file required state tax returns. Did you know that as of 2022, eight states have no income tax: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. New Hampshire doesn't tax earned wages and will join that list in 2027 when it finishes phasing out taxation on unearned income, such as interest and dividends.

Excise tax is a legislated tax on specific goods or services at the point of purchase such as fuel, tobacco, and alcohol. The next time you fill up at the pump point out how much tax you are paying for fuel.

Estate Tax is levied after the death of a person for the transfer of property to their heirs. It consists of an accounting of everything the deceased individual owns. In 2021, federal estate tax generally applied to assets over $11.7 million, but in 2022, it rose to $12.06 million. Generally, the spouse of the deceased person does not pay an estate tax. A tax professional is the best person to ask more specific questions.

It can be quite enlightening to compare your gross pay versus your net pay. Gross pay is what is earned before taxes, benefits, and other payroll deductions are withheld from wages. The amount remaining after all withholdings are accounted for is net pay or take-home pay.

Try to prioritize teaching your children the purpose of taxes as well as how, when, and where they are filed each year. It’s best to start the conversation about taxes early, rather than waiting until they are older and facing a potentially more complicated tax situation. Kids need to understand that filing taxes is a serious yearly responsibility even though they may not need to file taxes quite yet. Once kids have a job or are accruing passive income on investments, help them stay organized and remind them of the importance of keeping W-2 forms, receipts, and any other documents needed for filing. Encourage your working teens to think about budgeting for potential tax bills and avoid waiting until the last moment to file taxes. Tax season begins in January, but Monday, April 18, 2022, is the filing deadline for most taxpayers (unless you ask for an extension), so be sure to circle it on your calendar.

At this point, your working teens may question why so much of their paycheck is taken for taxes? Remind them that the government creates the taxes and they should do a little research about Congress. Congress must pass bills to increase or decrease taxes. It is important for kids to understand how government works, become informed citizens, and become aware of election issues.

Helping your teens understand the connection between taxes and essential community services can help them make informed decisions as adults. It is important for parents to help demystify taxes for their kids as an important step on the path to financial literacy.

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