Tax Tips Blog

Brandon asks:I opened custodial stock accounts for each of my kids when they were born. If I sell some of the stocks that I bought do I need to file tax returns for each of my kids? Do I need to pay taxes on the gains (they should be around $15,000 each)? Someone told me that any gains from minor children do not need to be reported. Thanks, Brandon

My reply: Hello Brandon.

Yes, each of your children will need to file a tax return.

If your children each realize $15,000 in gains from the sale of their stock, then they will owe Federal income tax. I would not listen to tax advice from anyone who told you otherwise.

I guarantee you that if you sell stock a 1099 will be issued and the IRS will certainly start writing you love letters if they don’t receive a tax return.  All the IRS will know about is the sales proceeds, not the cost basis or net gain, until you tell them what the gain was. So, if you sold $50,000 of stock for a $15,000 gain, the IRS is expecting you to pay tax on $50,000 of income until you tell them that it was only $15,000.

If your children are old enough to sign their names, they can sign their respective returns. If not, you can sign for them.

If by chance you sell their stock at a loss, the loss is carried forward and can be used in the year the kids have other taxable income to offset.

Best wishes, Gina

www.GLGcpa.com

Rosemarie from Saugus, MA inquires: Re: your article on Hiring your children…Can you pay them by depositing money directly into a 529 plan for their education each month - as opposed to a pay check?

I reply:Hello Rosemarie! Thank you for visiting my blog. If you hire your children to work for you, in your business, and pay them a reasonable wage for their age and the service they perform, you can deposit their net payroll check into their Section 529 plan (or a bank account in their child’s name, or their own Roth IRA). You will still have to issue them a W-2 at the end of the tax year, but if your business is taxed as a sole proprietorship (Schedule C on Form 1040) or partnership (Form 1065), then you don’t owe any Social Security or Medicare taxes on your child’s wages until they reach age 18 years and 6 months. You don’t owe Federal unemployment tax until they reach age 21 and 7 months. Hiring your children may also help you establish a medical expense reimbursement plan, education assistance plan or retirement plan. Before you hire your children it is best to speak to your tax professional to make sure you are paying them a reasonable wage and have properly documented them as a true employee.

Best wishes, Gina

Are your children attending a day camp this summer so you and your spouse can work or go to school full time? If so, you may be able to get a tax credit for the fees you paid for them to attend day camp.

A tax credit reduces the amount of tax you pay dollar for dollar, unlike an itemized deduction, which reduces your tax bill based on your tax rate. In 2006, the child and dependent care credit can save you up to $3,000 if you spend that much on care for one child under age 13. If you have more than one child in that age group who qualifies, the credit can save as much as $6,000.

Money spent on care for disabled older children also is covered. For all eligible children, the tax credit ranges from 20% to 35% of the money spent on eligible child care.

Summer day camps are considered eligible child care. Overnight camps do not qualify.

As with most credits and deductions, the higher your income, the lower the credit available. If your family income is over $43,000, the credit rate is 20%.

How would this work?If you spend $500 sending your eligible children to day camps this summer, so you and your spouse can work, and your income is greater than $43,000 you will save $100 in taxes. If you spend another $5,500 during the school for before and/or after school care, such that you and your spouse can work, you will save $1,200 in taxes.

If you are self-employed and considering hiring some part-time help you should consider hiring either your children or your retired parents. Depending on their abilities and skills your family members can clean your office, file papers, answer phones, design or update your business website, mow the lawn outside your office or just about anything that relates to your business.

No matter who you hire, you need to do it properly in order to get the deductions you deserve. First, make sure that you pay them reasonable compensation for the work you are having them do. The courts already have ruled that you can deduct taxes for any “reasonable wages” that you pay your children ages 7 or older to perform duties related to your work. If you previously had someone else doing this same work pay your family members what you were paying them. If this is a new position then a place like Salary.com may be useful in determining what the current pay level is for these types of services. Document the job description and how the salary was determined.

NOTE: Child labor laws vary from state to state, so before you hire a child review your state’s child labor laws. The federal labor law applies in all states; if the state and federal law differs, the stricter one must be followed. You can see a summary of the Texas Child Labor Law here: The Texas Child Labor Law.

Have all your employees, including your children and parents, complete forms W-4 and I-9. Form W-4 will tell you how much you have to withhold from their paycheck. Form I-9 provides proof of their eligibility to work in the United States. Both of these form can be downloaded from the IRS website.

All your employees should be either using a time clock, punching in and out or writing their time down on a time sheet. Pay all your employees with a business check. Your children can always endorse the check over to you for cash to replace their allowance or accumulate the money for college tuition.

At the end of the work year, file a form W-2 with the IRS for each employee.

Okay, so where are the tax benefits?

If your business is unincorporated (a sole proprietorship or a LLC taxed as a sole proprietorship) and your children are under age 18, you will not have to pay Social Security or Medicare tax and, normally, no state unemployment or disability taxes, either. Assuming this is your children’s only source of income, the wages you are paying them are considered “earned income,” which means that the first $5,150 received by each child in 2006 is tax-free.

So, let’s say I have three children, ages 12, 14 and 16. I hire each one to work for me in my unincorporated business and pay each one $9,150 in 2006. Because they are all under 18, I pay no Social Security, Medicare or state unemployment/disability taxes. Because of the standard deduction, in 2006, the first $5,150 earned by each child is not taxed, but could be saved to help pay for their college education (or buy their first car). The next $4,000 could be sheltered by setting up IRAs for each child. The net result is that I have paid my children a total of $38,600 ($9,150 x 3) that I can deduct from my business income and is tax-free to my kids. If I am in the top marginal tax bracket of 35%, I’ve just saved $13,510 each year in federal taxes alone.

Okay, but are there tax benefits to hiring my parents?

Certainly. If you employ a parent, his or her wages are subject to income tax withholding, Social Security and Medicare taxes, but not Federal or State unemployment taxes. The wages you pay your parents are still deductible to you; therefore you will save on your federal taxes the same way you did in the above example with your children.

NOTE: If your parents were born January 2, 1941, through January 1, 1942, their full retirement age for retirement insurance benefits is 65 years and 8 months. If they work and are full retirement age or older, they may keep all of their Social Security benefits, no matter how much they earn. If they are younger than full retirement age, there is a limit to how much they can earn and still receive full Social Security benefits. If they are younger than full retirement age during all of 2006, they will deduct $1 from their benefits for each $2 they earned above $12,480. If your parents attain full retirement age during 2006, they will deduct $1 from their benefits for each $3 they earn above $33,240 until the month they attain full retirement age.

Hiring your children or parents doesn’t increase your chances of being audited, and it has the potential to increase family wealth substantially.