Kids and Taxes (keep the money in the family)
Article by Sondra P. Gaylord, Enrolled Agent


If you’re like most taxpayers in the United States, your 1040’s will be coming to your home right after Xmas. This year, promise yourself: I will not pay one dollar more of tax than that to which I am legally bound. Let’s talk about the children. We’ll touch on items of safety, security, and keeping money in the family.

Each child must have a social security number. (You knew that!) Be sure the number on the return matches the number on their card. And, any child born during the year is an exemption, even if that child took only one breath.

Safety

How would it feel if your child needed medical care and you suddenly discovered he/she wasn’t covered under your employer’s medical insurance plan? Ouch! That can happen in a case where the parents separate/divorce. Some medical plans require that, to be eligible for coverage, that child has to be on the employee’s tax return. Ask your personnel people at work. We urge parents in our practice to hire their children. This works very well if the parent has a bona fide “business on the side”, a trade or investment-producing property such as rental units. It works even if the parent is employed full-time.

Q. Why is it prudent for children to have income?

A. Because 40 quarters of coverage makes the child eligible for disability benefits. Don’t you know of a kid who was injured in sports or a car wreck? It tragically happens. This is the cheapest lifetime coverage available.

Q, How does it work?

A. Elegantly! First, the work must be real. Keep a log or diary of work done and the pay may only be what you’d pay a stranger to do the same work. But even small children can file, answer the telephone, deliver messages, and help with mailings. Infants used in advertising can be paid a reasonable wage. Next, the pay at the end of the year must be transmitted on a W2 to the IRS. Wages, not sub-contracting. Wages to your child under the age of 18, require neither social security nor unemployment benefits be withheld (though we strongly recommend that you opt to pay it (for the above disability reason), and no unemployment insurance. It is, in essence, a direct transfer of money. And, by the way, your medical coverage can be deducted for your family and yourself directly off your business income under Code Section 105. Ask your tax advisor. It could save you tax dollars to do it this way.

Security

Consider starting that college fund early. Remember the $3,600.00 you paid your kid out of your small business? (4 quarters) That check may go into a bank account on behalf of the child. The IRS likes to see at least monthly checks for services rendered by the child, rather than one annual payment. Our first choice for such savings is a Roth-IRA for the child. Up to $3,000.00 a year can be saved. It then grows tax-exempt till the child is ready for college. Then, every dollar (compound that at 6% over 18 years!) pulled for education is tax exempt! S/he doesn’t use it? Doesn’t need it? The rules are first-in-first-out, which makes the money he put in completely tax exempt. If he simply doesn’t touch it till he’s 59 ½ s/he has a fabulous retirement in place.

Q. What about your kid’s tax on that earned income each year?

A. No problem! S/he gets a Standard Deduction of $4,750.00 in 2003. (You get the exemption).  It wipes out the entire $3,600.00 but s/he's "paid tax" on it by reporting it. The social security tax due on the $3,600.00 will be about $275.00. Cheap enough for a lifetime of coverage after 10 years (40 quarters).

Keep the money in the family

Consider the following: when your kid buys a car, you hold the paper (i.e., your child pays you.) The same with a house. Caution: you have to have the right kind of kid. Not every kid is ready for this! The documents must be legal and arms-length as they are with the bank. This often allows a child to have a house before S/he would otherwise be able to purchase. And it gives you a stream of income. You must use “bank” interest rates though you may opt for the low end of those. This works particularly well when the son/daughter is going to college. You purchase a house under Code Section 280A (Equity Sharing). The child rents out to two or three other students. Collects rents, supervises the housing, manages the property. He makes the bank payment directly. You pay him to manage it. He graduates? Sell the house, probably for a gain. This allow your child great flexibility of choice in housing at college. Remember, you have to know your kid. In the above instances, because there were legal documents and bona fide debt, if the enterprise falls apart and becomes worthless, you have a bad debt, deductible as short-term. (Watch those Ps and Qs).

About the EA

At the Dog Therapist's...

Sondra Gaylord (my Mom) is an Enrolled Agent in Youngstown Ohio who often uses dog illustrations to explain complex taxation concepts. To learn more about her practice see: http://www.planningforlife.info/sondra.htm

To see more of her illustrations:

 


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