Roth for the kids | Ed Slott and Company, LLC

Roth for the kids

Gary wants to gift $3,000 for each of his 2 grandkids to fund a Roth account each of the next 6 years. Gary's son, Chet, plans to pay each of his 2 boys $250/mo for chores that they will do for work to show income to allow for the Roth contributions. This seems like a legit way to accomplish the end goal, which is the Roth accounts. Since there is no personal exemption in 2018, i'm assuming they will have to file a tax return, but will not have to pay any tax on the $3k that they earn since the amount is well below the standard deduction. What am i missing that might be problematic?

Are these kids old enough so that whatever hourly rate is paid to them is reasonable for the work performed?  If so, the contributions could be made. If these children do not have any unearned income, this amount of earnings will not require them to file a return, with or without the Roth contribution.

  • IRA contributions require compensation from an employer.
  • The parents are not an employer and the children's chores are not employment.
  • When they are teenagers and perform tasks that could and especially have been performed by third parties. You might be able to consider them household employees. Two common examples are babysitting and landscaping. Many tax experts still consider even this illegitimate.
tim-timwolfecpa.com's picture

Wouldn't for example income from babysitting be considered earned income from self-employment?

From Kaye Thomas at Fairmark.com:  

"Household chores  Why not use a child’s earnings from household chores to meet the earned income requirement? Let’s make some favorable assumptions: 
  • The child is actually doing work for the money.
  • You’re paying only a reasonable hourly rate for the work.
  • You have good records to prove that the work was done and the money paid.

 Will that do the trick? Strangely enough, there’s no clear guidance on this issue, but the answer seems clear enough to me. Payments to family members for household chores are not taxable income, so they can’t be used to support contributions to IRAs. It’s difficult to prove this income isn’t taxable. The Internal Revenue Code says all income is taxable unless an exception is made, and there’s no exception for amounts paid by parents to family members for household chores. Yet this is one of those things we all know instinctively. No one ever reports this kind of income on a tax return, and no one thinks they’re cheating when they fail to do so. The IRS has never suggested that this income should be reported. Just imagine the uproar if the IRS tried to collect tax on the money parents pay their children to babysit younger siblings or mow the lawn. Here’s what the late Boris Bittker, the leading authority taxation of the family, has to say on the subject: 

“Intrafamily transfers of this type can be properly viewed as excludable by a higher authority than the language of [the Internal Revenue Code] — a supposition, so obvious that it does not require explicit mention in the Code, that Congress never intended to tax them.”

 If the income isn’t taxable, it can’t support an IRA contribution. You can’t turn it into “good” income for this purpose by choosing to treat it as taxable income. There’s little chance the IRS will actually challenge IRS contributions based on income from household chores, at least if you keep the contributions within the limit of amounts actually paid as reasonable compensation for work actually performed. But that doesn’t mean these contributions are legal and proper."

 

  • I certainly do not propose to have the tax gravitas that Kaye has and agree common household chores can never be the basis to pay your children compensation to justify IRA contributions.
  • I do belive tasks that you have paid third parties for or third parties have paid your chidren for, can be the basis for paying your children compensation for those tasks. You have established that those tasks have a far market value.
  • Two examples:
    • Babysitting; If you have paid someone for babysitting or your child has been paid for babysitting. What you pay your child for babysitting can be considered compensation.
    • Landscaping; If you have paid someone for landacaping or your child has been paid for landacaping. What you pay your child for landacaping can be considered compensation.
  • However, it should never be considered self-employment. Both from a practical and tax point of view they are household help. They can never meet the IRS' criteria for IC status and why would you possibly want to have them pay SE taxes, when they would not have to pay FICA or FUTA.
  • Publication 926 Household Employer's Tax Guide, Table 1. Do You Need To Pay Employment Taxes? Specifically states that you do not have to withhold and pay social security and Medicare taxes or pay federal unemployment tax for your children < age 21.
  • You have to report their wages on a Form W-2 if >= $600. I would do it not matter what the wages to document them. You should also complete a Form W-4 electing exemption from withholding.
  • I would not possibly consider this until they were at least teenagers and thn shortly the issue is moot as they will be able to gain regular employment.
 

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