Understanding earned income reporting rules for custodial Roth IRA limits

[jyeh74]

A child under the age of 18 has earned income doing small jobs and tasks.  They make about $7000 a year all paid in cash.  Parents will match $7000 into custodial Roth IRA for the year.

And according to these two article, if the earned income is less than $14,600 a year for 2024, the kid does NOT have to file taxes? 

https://turbotax.intuit.com/tax-tips/family/at-what-income-does-a-minor-have-to-file-an-income-tax-r...

https://www.calcapmgt.com/resource-center/tax/does-your-child-need-to-file-a-tax-return#:~:text=Your....

So confirming the kid doesn’t have to file taxes since it is under $14,600 and in cash.  Parents can contribute $7000 into custodial Roth IRA?

[Bsch4477 · Accepted solution]

The contribution is limited to the lesser of $7,000 or net earned income. Since they had self employment income over $400 they have to file a return and pay self employment tax. TurboTax will subtract the self employment adjustment from earnings and that’s the maximum amount they can contribute to the IRA. 

[jyeh74]

This is confusing.  It says limit is $14,600/year in order to have to report taxes not $400/year.  Is $14,600 from a W2 and $400 from cash?  Anyone who gets a summer job will easily make over $400 in cash.  You don't have to report cash to contribute to custodial roth ira?

[Bsch4477]

Yes, it is confusing since self employment income is treated differently. Scroll down in that reference you posted to see how self employment income is treated. 

[jyeh74]

So on a small $400 income in cash you have to report and pay taxes?

what is the rule on reporting earned income and contributing to Roth IRA?  If you don’t report it, you cannot contribute?

[VolvoGirl]

Well you have to report it as self employment income on schedule C but there won't be any self employment tax under $433.   Self Employment tax (Scheduled SE) is automatically generated if a person has $400 or more of net profit from self-employment. You pay 15.3% SE tax on 92.35% of your Net Profit (If it is greater than $400). The 15.3% self employed SE Tax is to pay both the employer part and employee part of Social Security and Medicare (FICA). So you get social security credit for it when you retire. It is in addition to any regular income tax you owe on it. 

If you have self-employment income you can only contribute up to your net profit reduced by the deduction allowed for the ER portion of your self-employment taxes. The 1/2 SE Tax amount will be on Schedule 1 line 15 which goes to 1040 line 10.

See IRS publication 590A page 6 about self employment income (it applies to both Traditional and ROTH IRAs)
https://www.irs.gov/pub/irs-pdf/p590a.pdf

[Bsch4477]

You can contribute to a Roth IRA without filling a tax return. For example, W-2 income below the filing threshold already has tax taken out so the IRS has its tax. But in the case of self employment income the IRS depends on the tax payer to pay those taxes. That’s why the lower threshold for filing a return in that circumstance. 

[jyeh74]

So what you are saying is, if they make $6000 a year, let’s say, in cash.  That is considered self employment. The parents have to report the $6000 and file their kid’s taxes in order to contribute $6000 to the custodial Roth IRA?  If kid doesn’t file taxes and report the $6000 as self employment earned income, then the parents cannot contribute $6000 into the custodial Roth IRA?  Someone confirm please.

[Bsch4477]

No. There are 2 separate issues. 
1. Yes, you can contribute to the Roth IRA without filing a tax return. 
2. If the child has a file requirement (which the child does with the amount of self employment you posted) the child has broken the law and is subject to penalties like any other non conforming tax payer. 

[VolvoGirl]

If you have a 6,000 Net Profit on Schedule C you can only contribute to a IRA up to $5,576.11.   You have to subtract 1/2 of the self employment tax which would be 847.77 / 2 = 423.89

[dimmi0205]

So if I deposited $850 in Roth minor IRA and the cash income was $395 (side gig) - then     

1. Should I file an Excess Return of IRA to the amount of $455 to ensure that I am putting an amount equal to the child's cash earnings of $395?
2. If the child's cash earnings are $395 (being less than $400), the child does not need to file any separate taxes - correct?
3.   Since Roth minor will show $395 contribution for 2024, does the parent need to report that $ amount as "other income" on parent's taxes?                      

[DanaB27]

1. Yes, if your child made an excess contribution for 2024 then you will need request the withdrawal of excess contribution plus earnings by the due date to avoid the 6% excess contribution penalty. The earnings are taxable in the year the excess contribution was made.

2. Yes, if the self-employment net income (gross minus expenses) is less than $400 and the child has no other income then the child isn't required to file a return. Please see Do I need to file my own taxes if I'm a dependent? for details.

3. No, you do not report this on the parent's tax return