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Hiring a child: Tax consequences of failing to pay wages

Children often follow their parents into the same profession. Summers spent working at the law office, for example, could spark an interest in the field.

Parents who hire their children need to pay in hard currency and not a vacation to the San Diego Safari Park or face questions about business deductions from the Internal Revenue Service.

In this blog, we will discuss a recent Tax Court decision that illustrates what can happen when a taxpayer takes improper deductions.

The taxpayer hired her three children to help at the office with tasks like filing and stuffing envelopes. According to the decision, she deducted about $15,000 for wages paid to her children as a business expense. The IRS did not allow the deduction.

The judge sided with the IRS faulting the taxpayer for paying her children’s wages in meals (this included a lot of pizza) and tutoring. In the decision, the judge noted parents are generally expected to provide that type of support for children. The taxpayer argued her children asked her to pay them in that manner. The tax litigation resulted in back taxes and a tax penalty.

When hiring a child there are several ways to avoid a similar issue. Pay the going rate for office work. Do not treat a vacation expense, meals or extra-curricular costs as wages. For younger children, putting wages into a Roth IRA is a way to build savings. Complete a W-2 for the child and make sure to withhold necessary taxes. Depending on the type of business entity you own and the age of your child, you may not need to withhold certain taxes.

To support any claimed business deduction for wages paid, keep detailed records. It may also be a great opportunity to have a child set up a bank account. Depositing wages into the account provides further proof of how much the child was paid. Then your child can use a debit card to pay for the pizza night out.

Source: The Wall Street Journal, "Tax Dos and Don'ts for Hiring Your Child," Laura Saunders, July, 18 2014

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