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August, 2004 Tax Tip

Employ Your Child – Everyone Wins


If you have a child you may be able to turn a nondeductible outlay into a deductible expense.  If you are in business, consider employing your child to turn what was your child’s allowance into a tax deduction for your business.  The salary payments are deductible provided that the child performs bona fide services for the business and the compensation is reasonable for the services performed.


IMPORTANT TIP:  Keeping good records detailing the time spent and the nature of the services performed is important.  The IRS generally applies close scrutiny to family situations.


Another tax break to consider is that wages of your child under the age of 18 are exempt from FICA tax if your business is unincorporated.


A child can earn up to $4,850 tax free in 2004 because the wages can be offset by the standard deduction.  This tax-free threshold is increased by $3,000 if the child contributes this amount of earnings to a deductible IRA.  Even better, put that amount into a Roth IRA to build up tax-free income over a lifetime.  There is no minimum age requirement for making IRA contributions.


In addition to the tax advantages offered by employing your child, other benefits to consider include teaching a skill, responsibility, and other intangibles.


CAUTION:  When employing your child be sure to comply with state child labor laws.


If you employ your child you need to make sure you protect your dependent exemption which is a tax deduction of $3,100 in 2004.  If your child is 19 or over and is not a full-time student, earnings (together with any investment income) of more than $3,100 in 2004 will prevent you from claiming a dependent exemption for your child on your return.  The same holds true if your child is age 24 or older, regardless of student status.


Even if your child does not fall into these categories, you can lose the exemption if your child provides more than half of his or her own support.  In figuring support, amounts spent on education are taken into account.  If your child has a student loan, the proceeds are treated as the child’s support if he or she is the primary obligor.  Your guarantee of the loan does not change this result.  If your child has a scholarship or fellowship it is not counted as support.


Therefore, to ensure you remain entitled to claim the exemption you should 1) encourage your child to save the earnings, and 2) keep track of support costs and make sure you pay more than half.


Please let me know if I can be of assistance to you in implementing these concepts.


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