Your kids’ summer employment: Yes, you need time sheets

Even children who work in the family business must have their time recorded on time sheets. What’s more, those time sheets must be credible, if you want to take a salary deduction for the wages you’ll pay your kids this summer. The Tax Court disallowed a salary expense deduction to a parent’s business when it found that the time sheets completed by his stepson weren’t credible. (Alexander v. Commissioner, No. 14921-13, U.S. Tax Court, 2016)

Poor time sheets sink salary deduction. During 2010, the taxpayer-stepfather ran a multi-level network marketing business. He said he paid his 10-year-old stepson $6,315 in cash wages. His duties: He took out the trash, vacuumed, set up chairs and cleaned the pool.

Aside from the fact that cleaning the pool isn’t business-related, the IRS pointed out these problems:

  • Handwritten ledgers, with dates and amounts, along with a computer printout listing the youngster’s tasks, which were prepared in 2014.
  • Some of the tasks recorded weren’t ordinary and necessary to the taxpayer’s business—“help with new baby Mason,” “Malcolm 11 birthday,” “helping kids” and “paint.”
  • The taxpayer didn’t issue his stepson a Form 1099-MISC or a W-2 to report the income.

Those failings were enough for the Tax Court to conclude that the taxpayer’s evidence, namely the time sheets, weren’t credible. The $6,315 salary deduction was denied.

Wages or allowance? Lots of kids work in their family’s business during the summer. And although you can deduct wages paid to your kids, you can’t deduct allowance. If you set things up correctly, however, you can save tax dollars and provide your kids with real work experience.

Sole proprietors and spousal partnerships that hire their minor children don’t have to withhold or pay FICA or FUTA on their wages; FUTA isn’t due if children are under 21. On one hand, that’s a huge tax incentive. On the other hand, the IRS is likely to presume that those payments are nondeductible allowance, not deductible wages. The burden is on you to prove otherwise. Following a few rules can keep the IRS out of your hair this summer.

  • Always withhold income taxes, which means that your kids must fill out W-4 forms.
  • Pay fair market value for their services and pay them on your regular payday, along with everyone else. Upshot: Kids must keep credible time sheets. Also, don’t pay flat amounts that you determine at the beginning of the year (or the end of the summer). 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.

A step-by-step payroll compliance guide to each pay period, month and calendar quarter of the year is now available. Download it free here.