The outlook for summer jobs for young people remains cloudy. Although the unemployment rate of 17.3% for workers ages 16 to 24 was down slightly in May compared with the 18% rate of a year ago, it was still far higher than the prerecession level of 9.9% in May 2007, according to the Department of Labor.

The good news, for those who can find—or invent—jobs for themselves this summer, is that Uncle Sam’s tax rules may offer opportunities for savings.

The most favored young workers are children under 18 who are hired by parents to work for sole proprietorships or husband-and-wife partnerships. Both the children and the parents can skip Social Security or Medicare tax on the child’s pay, which this year comes to 13.3%. There is no limit on this exemption, and the workers also aren’t liable for federal unemployment tax.

What’s more, the business owner can take a deduction for the child’s pay, and the teen usually won’t owe taxes on income up to the standard deduction, which is $5,800 for individuals this year. Total tax-free income swells to $10,800 if the child puts the next $5,000 of pay into a tax-deductible individual retirement account, says Don Williamson, a tax expert with American University’s Kogod Tax Center in Washington. Mr. Williamson has helped several families take advantage of this boon.

There are ground rules, of course. Compensation has to be fair enough to escape an Internal Revenue Service agent’s scrutiny, so be prepared to provide examples of comparable pay. But if Junior has whiz-bang skills in Web design or programming, he or she can be paid at the going rate or a bit more.

Summer workers who are older or who can’t work for a family business may reap other tax benefits. But there are traps for the unwary. Here are tips from tax experts:

• Know your status. Young workers often don’t know whether they are employees or independent contractors, says Robert Gard, an Atlanta-area CPA with Gard & LaFreniere LLC. There’s a big difference: Unlike employees, contractors don’t have income or payroll taxes withheld, so they (or their parents) may have an unpleasant surprise when a 1099 form arrives and taxes are due the following spring. While income taxes don’t usually kick in until $5,800, the payroll-tax threshold is $400.

Mr. Gard and others also suggest independent contractors track deductible expenses such as mileage or uniforms while working, because they can be hard to reconstruct later.

• Pay attention to the W-4 form. If the worker is an employee whose total earnings for the year won’t incur income taxes, he or she should file a W-4 form claiming exemption for withholding. That avoids having to file a return to reclaim tax payments the following year. Appropriate payroll taxes will still be withheld.

• Take advantage of IRA options. Workers may contribute earned income up to $5,000 to traditional or Roth IRAs, which offer tax-free growth. Contributions to a traditional IRA are tax-deductible but withdrawals are taxable, whereas Roth contributions aren’t deductible but withdrawals are often tax-free. Given that young workers usually have low tax rates, a Roth IRA is often the better long-term deal.

Experts say funding an IRA can be a terrific gift by a loved one to a young worker. “It provides tax shelter and teaches something about savings as well,” says Joe Kristan of Roth & Co. in Des Moines, Iowa. Deborah Fox, of Fox College Funding in San Diego, says that for financial-aid purposes, a gift used by a young worker to fund an IRA is considered student income in the year it is given. After that, IRA assets are off-limits.

• Keep “kiddie tax” effects in mind. “Unearned” income such as interest, dividends or capital gains greater than $1,900 received by children is often taxed at the parents’ rate, and this can continue up to age 24 if the child is a full-time student. But this provision doesn’t apply if the child is between 18 and 24 and has earnings that are more than half of his or her support.

In addition, a child liable for this tax who also earns income must file a separate tax return. If the child has no earnings from work, the parents often have the option of claiming the income on their own returns.

Experts say it often is better to file a separate return for the child anyway, because that avoids raising the parents’ adjusted gross income, which can clip other benefits.

• Know the rules on paying children for work at home. What if Junior can’t find a summer job but you want to pay him or her to paint the house or do other work? According to IRS spokesman Eric Smith, there is a break here for children under 21: No federal payroll taxes or unemployment taxes are due on the payments.

Here the parent can’t take a deduction for the pay, as would be possible if the child were working in the parent’s trade or business, but the child could skip income tax at least up to the standard deduction and would be eligible for an IRA. For more information, especially about required recordkeeping, consult a tax professional or see IRS Publication 15.

Source: WSJ Laura Saunders