Is it legal to pay your young children for household chores to generate earned income for purposes of contributing to a Roth IRA?
I have a young son and as soon as he is able to complete household chores (laundry, taking out the trash, pulling weeds, doing dishes, washing the car, etc.) I am considering paying him reasonable amounts for each specific task (and documenting this) so he has earned income and then contributing up to his annual earned income or the contribution limit in a custodial Roth IRA for him. Even better, because I am a parent hiring my minor child, it does not appear that my son would have to pay self-employment taxes (http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Family-Help). I have Googled this and have heard conflicting advice, but the preponderance of the evidence suggests to me that this is legal. I do not plan to take any deduction for the amounts paid to my son as the work would not be for a business, but just personal expenses.
Paying Children to Make IRA Contribution
Can anyone advise on this and provide guidance on the specific steps (documentation/filings/etc.) that are recommended? Unfortunately I have not seen guidance on point from the IRS. The tax court cases I have read primarily address businesses attempting to take deductions for payments to children for household tasks (generally not permissible, by the way).
Firstly, are you trying to take an inappropriate deduction on your tax return? No. So they can’t accuse you personally of a falsely filed return. In that sense you are safe from a problem. Done there.
For your son, if the IRS intends to challenge it, first they could argue it was a gift. Is your son really worth what he is paid? How is this money different from any of the other things you give him a year? This could happen despite any record keeping you decide to do.
Next, if the income is going to be under the standard deduction anyway what does the IRS care? He is currently not going to pay tax. So the only real issue is if they IRS is going to assert that you are fraudulently giving your son income to avoid taxable income at retirement 50 years from now. I don’t see them putting any effort into this.
I would say you can do it. Your best defense is going to be good records, so each time a task and fee per task or hour is completed write it down in a file. I don’t think you are obligated to fill a 1099 out and report it to the IRS, but I don’t deal in those matters often. If I were guessing though, just drop it on the other income line and be done with it. These small potato issues aren’t worth more than a letter from the IRS.
However, I would be very careful with this. Let us assume that paying your son for house chores would count as earned income thus allowing him to contribute to a Roth IRA. Depending on how much you pay him over the course of the year, your son may end up owing taxes due to the limited basic standard deduction for persons claimed as dependents ($1,050 for 2015). Overall, I would recommend putting money into a 529, it would be a lot less work on your end and you wouldn’t have to worry about any legality issues.