Summer means kids working in the family business. But beware. The Tax Court tossed a sole proprietor’s effort to deduct as wages payments made to her children. According to the court, there wasn’t any consistent correlation between the hours worked and the amounts recorded as wage payments. (Ross v. Commissioner, No 8728-13-S, U.S. Tax Court, 2014)
Paper trail to no avail. According to the taxpayer’s meticulous records, her children, ages 8, 11 and 15, were paid to shred documents, stuff envelopes, copy, sort checks, file and take out the trash.
Snag: Her payments, which she matched to receipts, were primarily made to third parties and were for such items as pizza and educational computer games. In addition, notations in her checkbook indicated payments for “kids” or their initials next to check-card purchases.
The taxpayer deducted the payments as wages. The IRS disallowed the deductions as personal expenses.
Taxpayer: The receipts were for expenses that her kids directed her to make, she matched the expenses to their earnings and made the appropriate charges against them. The Tax Court ruled for the IRS.
Tax Court: There is no correlation between the dates and the amounts of payments and the hours the children supposedly worked. The court noted, for example, that in one month, the oldest child was “paid” $132 and worked 39 hours ($3.40 an hour), but in another month, the same child was “paid” $515.21 for 20.5 hours ($25 an hour).
The value of the meals and the educational computer games was nondeductible in any event, the court said, since parents have a legal duty to support their children.
Keep it in the family. Sole proprietors who hire their minor children don’t have to withhold or pay FICA or FUTA on their kids' wages. That’s a huge incentive. But the IRS is likely to presume that those payments are nondeductible allowance, not deductible wages. Following a few rules can keep the IRS out of your hair this summer.
- Always withhold income taxes, which means that your kids should fill out W-4 forms
- Pay for services performed. Upshot: Kids must keep time sheets. Also, don’t pay flat amounts that you determine at the beginning of the year (or the end of the summer), and avoid payments in kind (e.g., paying off credit card bills) and calculating pay to exactly equal the year’s standard deduction
- Provide your kids with W-2s at the end of the year.