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Beauty and the Tax Beast

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in Small Business Tax

As far as the IRS is concerned, income is generally taxable to the person who earned it, regardless of his or her age. For instance, if a child earned a few hundred dollars from mowing lawns this summer or even millions from acting in a movie, the child is responsible for paying the tax, not his or her parents. At the same time, a child may be able to deduct certain expenses to offset the taxable income.

The same basic principles apply to taxable winnings from contests. In a new case, the Tax Court wouldn’t allow the parents of a precocious beauty pageant winner to deduct expenses attributable to their child, even though they were the ones paying the tab. (Lopez, TC Memo, 2017-171, 8/30/17)

Facts of the case: The parents began entering their daughter in beauty pageants when she was 9 years old with the hope that it would lead to a performing career. At each pageant, she would participate in different segments, including photogenic and interviewing competitions. To attend the pageants, her parents paid significant sums for travel, outfits and other items.

In 2011 and 2012, the daughter won several events and received prizes of $1,325 and $1,850, respectively. The pageant expenses for 2011 totaled $21,732 and $15,445 for 2012. Her parents reported the winnings as taxable income and deducted the expenses on their own tax returns for the tax years in question.

Generally, prize winnings are counted as income because they are considered “payment in return for services rendered.” In previous instances, the Tax Court has consistently treated remunerations from beauty pageants as compensation for services even when scholarships were involved. And it saw no reason to deviate in this particular case.

Accordingly, the beauty pageant winnings were treated as being taxable to the daughter, not the parents, and only she could deduct the expenses—even though the parents paid them.

Presumably, the parents had tried to deduct the expenses because they were more valuable to them in their high tax bracket. Note that the costs were about 10 times the amount of the income.

Tip: The child might contribute the winnings to a Roth IRA.

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