06.16.2012
You heard that right — you may be able to get a deduction for your teenager’s football training or your middle schooler’s electric guitar lessons. We teased our clients with this notion at the beginning of tax season and it sure got their attention. My own daughter chose to ride horses competitively during high school and I got very familiar with the role of carrying around the checkbook (and practicing, “No — n-o spells NO.”) I kept trying to find a way to put Alex (the horse) on my return as a dependent. He cost more than anyone actually living under our roof.
There is a way to “deduct” your kid’s expensive activities — but there is a catch. You have to own a business. It can be a sole proprietorship or an LLC, a partnership or a corporation (S or C). The trick is to hire your child to do a real job and get a real paycheck from that business. The paycheck is deductible to your business (and thus, indirectly, to you) and then…your child can help pay for his or her own lessons or training or clubs or equipment.
If you are already running a payroll, it is a snap to add one more employee. If you are not running payroll, chat with your accountant about the pros and cons of hiring your kid–including the administrative cost of starting to do a payroll. Here are a few to consider:
Since I’m a CPA, I’ll start with the cons — it is my job to rain on parades with reality checks:
• Payroll taxes – unless you are a sole proprietor, you must treat your child’s paycheck the same as any other employee in your company–you must withhold for Social Security and Medicare and match it (or exceed it, which is the law for 2012). You also must pay unemployment tax and you should check with your worker’s comp carrier because you will most certainly have to cover your child. Sole proprietors catch a break – ask your CPA.
• Contract labor – don’t do it, period. Do not hire your child as an independent contractor, thus avoiding payroll taxes. Your child is not in business — she is your employee. My clients know that I am fond of saying, “If it looks like a duck and quacks like a duck…it’s a duck (ie employee).” Hiring anyone as a contractor who ought to be an employee is just plain illegal and the IRS is on the warparth.
• Cost – as mentioned above, if you already have a payroll, adding someone is pretty simple. But if your kid will be your first employee and you have never run a payroll — get help (from your CPA). Help costs money, but not getting help could cost a lot more money in the long run. You want to get set up correctly and know the rules or you could end up jeopardizing the deduction and facing a boatload of penalties. Payroll is not hard…after you get the hang of it.
• FAFSA – if your kid is about to go to college or is in college…beware – his earned income can impact financial aid.
Now for the pros – and they are all pretty darned positive:
• Follow the money – you are going to have to pay for the lessons or activities anyway (unless your child manages to get a job working for someone else). Why not provide your kid with the money in the form of wages for a job performed– with the caveat that she will buy her own poms or track and/or horse shoes?
• Real job, real responsibility -here is your opportunity to help your son or daughter understand your business with a real reward — wages. You cannot just pay your child — it does have to be for a real job performed and realistically compensated. Best to draw up a written job description and keep time sheets or logs. Your child should have to follow the same rules as other employees, too. What a concept.
• Roth IRA – no time like the present to start saving for retirement :). Or a first home. With wages, your kid can begin to load money into a Roth IRA. Why a Roth? Because he probably won’t need a deduction as long as his annual wages (combined with ALL of his employment) is less than around $5,800 (2011) and he can withdraw the Roth after five years without penalty to buy a first home someday!
Here comes the disclaimer: every business owner’s situation is different and every kid is not the same (if you have more than one, you could write a book about that topic). To avoid unhappy endings, be sure to talk with your CPA about this strategy. You may decide that it is win/win. And you won’t have to fight over the price of new riding boots versus slightly used ones — your daughter can choose for herself based on what is actually in her bank. Now – about reconciling bank accounts…..