"Putting your youngster on your payroll can be a savvy way to take care of his or her
allowance at the expense of the Internal Revenue Service.
"Significant tax savings
can result merely by moving the money from one family pocket to another."
- Julian Block in
Homemade Money: Bringing in the Bucks.
Julian Block has been Barbara's tax expert through the years, generously
contributing his time and talent in checking the tax information in her books,
particularly in all editions of Homemade Money since first published in 1984.
Block's several books include:
Tax Tips For Small Businesses
Year-Round Tax Savings
Marriage And Divorce
The Home Seller's Guide to Tax Savings
Travel And Moving Expenses
For more information,
visit Julian's website.
Profit from Paying Your Kids
Special Tax Tips for
for the Current Year
by Julian Block
CAN YOUR CHILDREN HELP OUT with some of the chores connected with your business?
Then a savvy way to take care of their allowances or spending money—at the expense
of the Internal Revenue Service—is to pay them wages for work they do on behalf of
business. This holds true, whether it is a full-time, long-established operation or
just a new, part-time sideline.
Going that route isn’t just a strategy to save taxes for the family as a
unit. It also provides your children with jobs that put some “jingle in their
jeans,” familiarizes them with the business, and instills a bit of the old work
ethic. Here are several strategies to keep in mind when your business pays them
compensation that it deducts and they report on their returns.
Staying Clear of "Kiddie Taxes"
Putting your children on the payroll is a perfectly legal way to keep income
in the family, while shifting some out of your higher bracket and into their
lower bracket. This maneuver isn’t crimped by complicated "kiddie tax" rules
that drastically restrict the ability of parents and grandparents to shift
investment income from themselves to their lower-bracket children and
grandchildren by gifts of cash, stocks, mutual fund shares, real estate, money
and other income-generating assets. Recently revised rules further curtail
opportunities for families to shelter investment income.
Although the point is often overlooked, the onerous kiddie tax restrictions
aren’t applicable to children's wages, whether those earnings are derived from
babysitting, delivering newspapers, or even working for a parent-owned business.
The business gets to deduct the wages, which are taxed to the child at the
child’s own rate. Consequently, it might prove more advantageous to pay wages to
a child than to bestow properties on him or her that generate an identical
amount in income.
As is true of investment income, the child gets to offset earned income with a
standard deduction, but one that’s much greater. So the more income the child
receives as earnings, the more that escapes taxes because of the standard
The Way it Works
Whatever the child’s age, however, this arrangement can work very neatly.
Imagine that your business hires Nadine, your 16-year-old daughter, to do
clerical work after school, on weekends and during school vacations. Nadine can
use her earnings to support herself or put away for college, a wedding, a car,
or a post-graduation vacation. She sidesteps taxes on her wages to the extent of
her standard deduction.
True, earnings in excess of the standard deduction will lead to a tax liability
for Nadine. However, the excess typically falls into the bottom income-tax
brackets of 10 percent and 15 percent.
CAUTION: Unsurprisingly, the IRS bars any deductions for the value of meals
and lodgings furnished by you. That is not considered part of Nadine’s
compensation. As a parent, you are legally obligated to support her.
Social Security Taxes
Generally, the wages you pay Nadine and other employees are subject to Social
Security (6.2 percent) and Medicare taxes (1.45 percent) that aggregate 15.30
percent (7.65 percent for both employer and employee). But Internal Revenue Code
Section 3121(b)(3)(A) authorizes an exemption from these taxes for wages you pay
to your under-age-18 sons or daughters. The exemption applies when you do
business as (1) a sole proprietorship (IRS lingo for the lone owner of a
full-time or part-time business that is not formed as a corporation or a
partnership with a partner other than your spouse) or (2) a husband-and-wife
partnership. Consequently, whatever income you are able to shift to your
children lowers your Social Security taxes by as much as 15.3 percent.
Roth Individual Retirement Accounts
Another break for Nadine is that each year she has the option to put part of her wages into a
Roth IRA. To be eligible for a Roth, she must have earned income. But the source
of that Roth contribution need not be her wages. It can be a gift from, say, you
or her grandparents. Sure, she gets no deductions for her Roth contributions;
but the write-offs would be worth little or nothing anyway because her brackets
usually are low—15 or 10 percent—or even zero. The big benefit is that those
Roth contributions will grow without being taxed. Nadine can withdraw
contributions at any time if she needs to tap the account. As for the earnings,
there are restrictions. Generally, she will be able to withdraw earnings free of
taxes only after she attains age 59-1/2, by which time they will have swelled
Dependency Exemptions and the Child Tax Credit
Legislation enacted in 2004 overhauled the rules that allow parents to claim
exemptions for their children. The revised rules impose several requirements for
claiming under-age-19 children like Nadine. The new rules are unlikely to
disqualify you from claiming Nadine, regardless of how much she receives as
reportable income, whether wages from you or income from other sources.
Under the revised rules, the key requirement is that Nadine must have the
“same principal place of abode”—IRS lingo for residence—as you do for more than
half of the year in question. The IRS disregards temporary absences by Nadine
attributable to vacations, sickness and the like.
Another requirement is that Nadine can’t provide more than half of her support
for the year. But the IRS counts only what Nadine actually spends for her
support, not the entire money available for that purpose. For instance, wages
that Nadine moves into Roth IRAs or simply saves don’t count as spent by her for
There is yet another tax trap: No exemptions for Nadine or yourself if you're subject to
AMT, alternative minimum tax.
Claiming an exemption for Nadine or another child under the age of 17
qualifies you for the child tax credit, provided you satisfy its eligibility
requirements. Under current law, the credit is $1,000 for each child.
Restrictions on who qualifies for the credit disqualify upper-income
The child tax credit and other credits are subtracted from the tax itself,
resulting in dollar-for-dollar reductions of the tax that a person would
otherwise owe; write-offs for exemptions and other deductions merely result in
reductions of the amount of income on which to figure taxes.
The distinction is critical. Whereas a
deduction of $1,000 is worth only $250 for someone in a 25-percent bracket,
dropping to just $100 for someone in a 10-percent bracket, a credit of
$1,000 reduces a person’s tax tab by $1,000, whatever the bracket happens to
No matter how closely you follow the rules, IRS auditors are understandably
suspicious of deductions for wages paid to your own children. The write-offs
survive scrutiny only if you’re able to establish that the children actually
render services. Expect the feds to throw out a deduction for hiring, say, a
six-year old to do photocopies; someone that age likely lacks the skills or
discipline for office work.
Another hurdle is the “reasonableness” requirement. Wages paid to children can’t
be more than the going rate for unrelated employees who perform comparable
tasks. That doesn’t mean you have to be a parsimonious paymaster who doles out
only the minimum wage. But it does mean that you have to treat your children the
same as any other employee and keep the usual records showing amounts paid and
hours worked. Give them W-2 forms, even if they qualify to exempt their wages
from withholding for income taxes; use checks drawn on business accounts to
evidence the payments. Otherwise, the IRS might contend that the payments
exceeded the going rate or that your youngsters weren’t bona fide employees;
they merely rendered the token kinds of services that parents expect their
children to perform.
TIP: Responsible students are able to handle all kinds of chores. Some of the
more common ones include answering telephone calls, cleaning offices, addressing
envelopes, filing, bookkeeping, secretarial and other clerical work and making
deliveries. Nowadays, lots of kids are more adept with computers than older
What Will Trip You Up
Unfortunately, there are a number of ways to fall afoul of the IRS. In one
case, the Tax Court threw out deductions for payments over a two-year period by
an Indiana surveyor to his children, ages nine and eleven, for sweeping out his
office and helping him with surveys. For one thing, he kept no records of the
time they worked. And his case really went down the drain when the judge
examined the children's pay checks and found all of them had been redeposited in
the father's account.
In another case, the Tax Court concluded that the “salary” at issue, which had
been turned over by Dr. Anthony R. Furmanski, an Encino, California,
neurologist, to his teen-age daughter, was merely an allowance, and not, as he
claimed, wages paid for secretarial services at his office, and for regularly
answering calls from patients at his home when the answering service was off and
he didn’t want to be disturbed. Among other things, a dubious judge noted that
children normally answer the family phone. Nor was the doctor’s case helped by
his admission that he made the entire payment to his daughter in advance—and
paid nothing to his son for answering calls. The clincher was his failure to
keep any records showing when she worked for him at the office or at home, or,
in this particular situation, to withhold taxes on the payment.
Then there’s the frequently cited case of Walter and Dorothy Eller, who hired
their three children, ages 7, 11, and 12, to work at their mobile home parks in
California. During a three-year period spanning 1972-1974, the kids did the
following: cleaned the grounds and laundry room, performed landscape work,
maintained the swimming pool, read gas meters, answered phones, delivered
leaflets and messages, and made minor repairs. The Ellers deducted nearly
$18,000 of their payments to the children as "outside services," of which the
IRS disallowed about 90 percent as unreasonable.
But the Tax Court concluded that, had the children not done the work, the Ellers
would have had to hire someone else to do it. As the children performed
"substantial services," the court approved more than $15,000 as allowable.
Most of the disallowance was attributable to the 7-year old, although around
$4,000 of his earnings were allowed. "Experience teaches that 11- and 12-year
old children can generally handle greater responsibility and perform greater
services than seven-year-old children," the judge explained.
The key to winning these kinds of disputes:
Truly treat the children like employees; be able to document that the
children actually perform the chores for which they are paid, make sure that
the work is necessary for the business, and pay only reasonable amounts for
the jobs performed.
Julian Block, an attorney in Larchmont, N.Y., has been cited as "a leading
tax professional" (New York Times); "an accomplished writer on taxes" (Wall
Street Journal); and "an authority on tax planning” (Financial Planning
© 2013 by Julian Block.
All Rights Reserved. This article is excerpted from his book, Easy Tax Guide for Writers,
Photographers and Other Freelancers, praised by law professor James Edward Maule
of Villanova University as "An easy-to-read and well-organized explanation of
the tax rules. Writers, photographers and artists would be well advised to buy
The 2013 edition is now
available in Kindle format. Print copies of Julian's
books are available at
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