Summer is a great time to be a child. The school is out, and pools are open. However, for parents, summer is still a time to work. Some parents may want their child to work for them, because it will teach them life lessons about earning and saving money. Also, when they pay a child for work they perform, parents have an opportunity to shift income from their higher tax bracket to the child’s lower tax bracket. The child can then contribute their earnings to an IRA.
A recent court case emphasizes why it is important for parents to keep records if they employ their children. In Fisher vs. Commissioner Tax Court Summary Opinion 2016-10, the tax court mostly sided with the IRS in a case involving children employed by a parent.
The Fishers had hired their three children, all under the age of nine, to work in the mother’s law office during summer breaks. The children helped with shredding, mailing, photocopying, and answering phones. The tax returns for the mother’s business reported $29,000 in “wages to minor children” for the years 2006 through 2008. The mother did not maintain payroll records for her children, issue W2 forms to them, or withhold federal tax payments.
The IRS disallowed all the deductions for the wages. The Fishers disagreed, arguing that their children actually provided various services to the law practice and were paid through contributions to their Section 529 college education accounts. The tax court did allow for a deduction of $250 per child for each year, based on their ages, time spent at the office, and general nature of the duties. But this was a considerable reduction from the $29,000 that the Fishers originally claimed.
How Parents Can Do This Right
In order to ensure that they are documenting their child’s employment status correctly, parents should:
1. Maintain proper payroll records that clearly show the type of services performed, the hours worked, and when and how the payments were made;
2. Issue W2s to the child. While payments for services of children under the age of eighteen who work for a parent in a trade or business are not subject to Social Security and Medicare tax under certain conditions, they are generally subject to income tax withholding.
3. Pay the child wages that are ”reasonable” for the services performed.
4. Issue paychecks to the children. Afterwards, the child can fund the 529 plan, which does not require a federal tax deduction for money contributed.
For advice on how to document your child’s work status if you are their employer, contact me at firstname.lastname@example.org.
Susan A. Moussi, CPA, CFP®, CDFA SMD Tax & Divorce Financial Planning Consultants, Inc. Phone: 614.429.4172 email@example.com