topic Funding a custodial Roth IRA for children in Retirement tax questions

Funding a custodial Roth IRA for children

jyeh74 — Tue, 02 Mar 2021 14:57:39 GMT

My friend sent me this link https://www.marottaonmoney.com/fund-your-childs-roth-with-chore-income/

She is trying to open up a custodial Roth IRA for her young kids to teach them the value of saving at an early age and pay them to do chores around the house. It says that the first decision that must be made is how the child will be hired. When it comes to chores, there are two main options.

The child may be a self-employed independent contractor.
The child may be a household employee of their parents.

Number 1 seems like it is not realistic since they would have to report income and pay taxes on schedule SE. Not sure why any parent would want to make their child an independent contractor just to do chores around the house? Number 2 is what she is thinking that she wants to do. Essentially pay her kids to do chores around the house. Question is, if she is paying her kids cash, does she have to create a log for her kids for every single chore? i.e. Pay $20 to wash the car on this date. Pay $10 to clean the kitchen. If she is going to pay them up to the limit of $6000 annually for numerous jobs, does IRS usually check these things or does she have to report it on her 1040?

Re: Funding a custodial Roth IRA for children

jyeh74 — Tue, 02 Mar 2021 07:09:16 GMT

Also, if she is paying $6,000 to her child annually, does her child have to report taxes when they are a household employee?

Re: Funding a custodial Roth IRA for children

ColeenD3 — Tue, 02 Mar 2021 16:35:05 GMT

Child employed by parents.(p13) IRS family help

Payments for the services of a child under age 18 who works for his or her parent in a trade or business aren't subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.

If these payments are for work other than in a trade or business, such as domestic work in the parent's private home, they’re not subject to social security and Medicare taxes until the child reaches age 21.

Payments for the services of a child under age 21 who works for his or her parent, whether or not in a trade or business, aren't subject to FUTA tax. Payments for the services of a child of any age who works for his or her parent are generally subject to income tax withholding unless the payments are for domestic work in the parent's home, or unless the payments are for work other than in a trade or business and are less than $50 in the quarter or the child isn't regularly employed to do such work.

Re: Funding a custodial Roth IRA for children

jyeh74 — Tue, 02 Mar 2021 19:17:02 GMT

Since the children are not working for the parent’s business, it is more domestic chores around the house, then it sounds like the child does NOT have to do any taxes and neither does the parent need to report paying her children for the domestic work done. And it will be a few thousand a year. The annual limit is $6,000 from what I understand. If it’s paid in cash or a deposit into the child’s Roth IRA, then what is the recommendation to log the work (if any?).

Re: Funding a custodial Roth IRA for children

ColeenD3 — Tue, 02 Mar 2021 19:48:25 GMT

"unless the payments are for work other than in a trade or business and are less than $50 in the quarter"

If the children are being paid $6,000 per year, then that is more than $50 in a quarter. Also, in order for the IRA to register, there has to be earned income of $6,000 shown on a tax return. The proper way is by Form W-2. They are being designated as household workers.

Should they choose to issue the 1099-NEC, the contribution will be limited by one half the SE tax that they will pay.

Re: Funding a custodial Roth IRA for children

jyeh74 — Tue, 02 Mar 2021 20:08:00 GMT

I don’t follow. Didn’t you say that Payments for the services of a child of any age who works for his or her parent are generally subject to income tax withholding unless the payments are for domestic work in the parent's home?

Since this is for domestic work in the parents home, the child does not have to pay taxes, even if it’s $6,000 a year. But you’re now saying the parents have to issue a W2 or a 1099 NEC? Doesn’t doing this require a tax to be paid since the domestic work is now official earned income? I thought domestic work doesn’t need a 1099 or W2? How do one even issue a 1099 if you don’t own a company?

Re: Funding a custodial Roth IRA for children

ColeenD3 — Tue, 02 Mar 2021 22:14:49 GMT

What I am saying is that in order for this to be earned income for the purposes of contributing to an IRA, there has to actually be earned income on the child's return.

Re: Funding a custodial Roth IRA for children

jyeh74 — Tue, 02 Mar 2021 23:02:40 GMT

So a child has to do his or her taxes for $6000 earned income and Roth IRA contribution a year? I thought if earned income is less than few thousand (can’t remember exact amount) you don’t have to do taxes at all.

Re: Funding a custodial Roth IRA for children

jyeh74 — Tue, 02 Mar 2021 23:04:37 GMT

I just looked it up. Single filer (child) only has to report taxes for 2020 if over $12,400. $6000 earned income is less than that so you don’t have to report.

Re: Funding a custodial Roth IRA for children

jyeh74 — Wed, 03 Mar 2021 02:22:44 GMT

@ColeenD3 If a parent is paying their child cash, for doing household chores, as a "household employee" not "independent contractor", then the parent should NOT have to write a W2 or a 1099. It's cash deposited into the kid's savings account. That cash is considered earned income. And from your own turbo tax link, it states that earned income for dependents, and for single filers, only need to be reported if the earned income is greater than $12,400 a year. $6000 a year max limit is definitely lower than $12,400 a year.

Here is your own turbo tax link

turbotax.intuit.com/tax-tips/irs-tax-return/does-everyone-need-to-file-an-income-tax-return/L7pluHkoW

I will copy it here

When a dependent (child or adult) may need to file a tax return

Taxpayers who are claimed as a dependent on someone's tax return are subject to different IRS filing requirements, regardless of whether they are children or adults. A tax return is necessary when their earned income is more than their standard deduction.

The standard deduction for single dependents who are under age 65 and not blind is the greater of:

$1,100 in 2020
Or the sum of $350 + the person's earned income, up to the standard deduction for an unclaimed single taxpayer which is $12,400 in 2020.

A dependent's income can be "unearned" when it comes from sources such as dividends and interest. When a dependent's unearned income is greater than $1,100 in 2020, the dependent must file a tax return.

Re: Funding a custodial Roth IRA for children

Coolkids007 — Sat, 06 Mar 2021 05:32:30 GMT

@jyeh74 @ColeenD3
I’m really confused.

The original question has 2 questions in it. I actually looking for answers for the same 2 questions.

1.how to / how detailed the log for household chores?

2. is there a need for kids to file income tax?

If I have missed the answer, please direct me to it.

thanks for patience and efforts

Re: Funding a custodial Roth IRA for children

jyeh74 — Sat, 06 Mar 2021 03:46:37 GMT

@Coolkids007 from speaking to professionals, it’s good to have a log. Date, chores, how much pay per hour or how much pay for project.

From what I gather, single filers who make less than $12,400 of earned income per year are not required to report their taxes. If you pay your child $1000 or $100 for doing chores in your household, are you taxing them social security and Medicare? I can’t see a case where the answer is yes. Then are you supposed to write them a 1099? Probably not. It’s straight cash. But it’s still considered earned income for the child. Does the child report it if they want to contribute $1000 or $100 to their Roth IRA? Colleen is saying that the child has to report their taxes if they want to contribute that amount to their Roth IRA. But where does it say that earned income, paid in cash, not in a 1099 that is reported, doesn’t count toward Roth IRA contributions?

Re: Funding a custodial Roth IRA for children

Coolkids007 — Sat, 06 Mar 2021 05:31:44 GMT

Hello @ColeenD3 , any further thoughts or advice on which turbo tax products is used to handle this situation?

Re: Funding a custodial Roth IRA for children

jyeh74 — Sat, 06 Mar 2021 08:04:03 GMT

@Coolkids007
These articles should help demonstrate that your child doesn’t need to do their taxes for their earned income to be actually counted as earned income for purposes of contributing to their Roth IRA. Cash counts as earned income.

https://www.marottaonmoney.com/do-children-need-to-file-a-tax-return-to-fund-their-roth-ira-2020/

www.kiplinger.com/article/saving/t046-c001-s001-proving-a-child-has-income-for-a-roth.html

Re: Funding a custodial Roth IRA for children

ColeenD3 — Sat, 06 Mar 2021 14:57:54 GMT

No, the kids are not required to file a return due to income. I was thinking more along the lines of letting the IRS know that the account has been opened and keeping track of it.

Re: Funding a custodial Roth IRA for children

jyeh74 — Sat, 06 Mar 2021 19:05:46 GMT

@ColeenD3 Where you confused everybody above is where you said “in order for this to be earned income for the purposes of contributing to an IRA, there has to actually be earned income on the child's return.”

That is actually incorrect. Cash is not reported but it still considered earned income as long as there’s logs to back it up.

Re: Funding a custodial Roth IRA for children

jyeh74 — Tue, 09 Mar 2021 04:07:47 GMT

If parent contributes/matches child’s earned income to the Roth IRA, do parents have to report it under “charitable contributions” or somewhere else?

Re: Funding a custodial Roth IRA for children

MaryM428 — Tue, 09 Mar 2021 21:56:21 GMT

You cannot pay your kids to do chores like wash the car and call that earned income for a ROTH IRA.

If you own your own business, you can employ your children, pay them salary and open a Roth IRA on their behalf. But the kids must be doing real work, and you should pay them a reasonable wage.

IRS Employment Taxes for Household Employees

Re: Funding a custodial Roth IRA for children

jyeh74 — Tue, 09 Mar 2021 22:04:32 GMT

@MaryM428 according to the Marrottonmoney article that I posted on the first page, you can. Children are called household employees

For some reason, the link won't work so here is a copy and paste:

Childhood is a time of acquiring lots of behavior that will be useful for the rest of life. Just as learning to speak would be difficult if the child was never allowed to attempt to make the sounds, so too learning to deal with money is difficult if the child is never given the opportunity to attempt to handle it.

When it comes to teaching financial lessons, setting a good parental example is important, but actually giving the child some experience making wise financial decisions is essential. This includes both giving the child decision making authority with their own money and giving the child the means to earn money outside of or instead of an allowance.

We talk frequently with our now 2.5-year-old daughter about the certain tasks that every family member is expected to do. For example, we all are responsible for cleaning up after ourselves at the table or cleaning up our own clothes, toys, and things after we are done. However, there are also tasks for which my daughter is not responsible. In fact, I am responsible for them. However, I would be very interested in outsourcing these jobs to someone for pay. After all, the route from wealth to well-being is spending money to buy free time.

In this manner, there are many opportunities to pay your children. And if that payment can be counted as earned income, then the child is eligible to fund their Roth IRA. So the rest of this article is to step through the means by which you can use chore or odd job earnings to fund a Roth IRA.

The first decision that must be made is how the child will be hired. When it comes to chores, there are two main options.

The child may be a self-employed independent contractor.
The child may be a household employee of their parents.

Independent Contractor

If your child is an independent contractor, then the child’s earnings must be reported as Self-Employed on Schedule C. Also, if their net earnings from self-employment is more than $400, the child would need to pay self-employment tax (Medicare and Social Security) on Schedule SE.

The perk of being an independent contractor is that your child could work for many different families. For example, they could be neighborhood childcare, being paid both to watch their younger siblings and watch the neighbor’s kids.

It is important to note that even being an independent contractor runs into child labor laws.

If your child is under the age of 14, then, according to YouthRules.Gov, the list of potential occupations is limited to:

deliver newspapers to customers;
babysit on a casual basis;
work as an actor or performer in movies, TV, radio, or theater;
work as a homeworker gathering evergreens and making evergreen wreaths; and
work for a business owned entirely by your parents as long as it is not in mining, manufacturing, or any of the 17 hazardous occupations.

At age 14 or 15, the list expands to include the following:

retail occupations;
intellectual or creative work such as computer programming, teaching, tutoring, singing, acting, or playing an instrument;
errands or delivery work by foot, bicycle and public transportation;
clean-up and yard work which does not include using power-driven mowers, cutters, trimmers, edgers, or similar equipment;
work in connection with cars and trucks such as dispensing gasoline or oil and washing or hand polishing;
some kitchen and food service work including reheating food, washing dishes, cleaning equipment, and limited cooking;
cleaning vegetables and fruits, wrapping sealing, and labeling, weighing pricing, and stocking of items when performed in areas separate from a freezer or meat cooler;
loading or unloading objects for use at a worksite including rakes, hand-held clippers, and shovels;
14- and 15-year-olds who meet certain requirements can perform limited tasks in sawmills and woodshops; and
15-year-olds who meet certain requirements can perform lifeguard duties at traditional swimming pools and water amusement parks.

At age 16 or 17, any job that has not been declared hazardous by the Secretary of Labor is permissible for 16- and 17-year-olds.

Household Employee

If they are considered a household employee of their parents, there are a few exceptions that benefit everyone. First, your list of jobs allowed under child labor laws expands significantly as you are allowed to “work for a business owned entirely by your parents as long as it is not in mining, manufacturing, or any of the 17 hazardous occupations” at any age. Second, your child’s wages are exempt from FICA taxes if they are working for a business owned solely by their parent(s).

If you can be counted as a household employee depends on one question: Does the employer have control over how the work is done (such as when, where, with which tools) ? If the employer does, then the individual is an employee. As the IRS says, “The worker is your employee if you can control not only what work is done, but how it is done.” And later, “If only the worker can control how the work is done, the worker isn’t your employee but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business.”

When it comes to chores, most parents have specific guidelines on how and when they want the chores completed. They are also providing their children with the tools to do so. Furthermore, their child is normally not offering services to the general public. For these reasons, I would guess, most paid children are “household employees” of their parents.

The IRS examples of individuals who may be household employees are, “Babysitters, Butlers, Caretakers, Cooks, Domestic workers, Drivers, Health aides, House cleaning workers, Housekeepers, Maids, Nannies, Private nurses, and Yard workers.” As this list also overlaps with most chores parents want to delegate to their children, there is a strong precedent here for being able to count your children as household employees.

There is a benefit to being counted in this way. As the IRS states in its page on “Family Help,” “Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to social security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child.” This means that wages earned from their parent employer to an under age 18 child employee are not subject to the FICA taxes of Social Security and Medicare.

In Publication 926, Household Employer’s Tax Guide, the IRS raises the age to 21 for child household employees, stating “Don’t count wages you pay to any of the following individuals as social security or Medicare wages, even if these wages are $2,100 or more during the year. … 2. Your child who is under the age of 21.” It is also worth to note that, “You’re not required to withhold federal income tax from wages you pay a household employee.” Also, you only need to file forms with the IRS for household employees “if you pay any of the following wages to the employee: Social security and Medicare wages, FUTA wages, Wages from which you withhold federal income tax.”

These exceptions should make payroll in your household easy.

In this way as a Household Employer, you likely can pay your child any amount without having it be subject to withholding, Social Security, or Medicare and thus without having to present any IRS forms to your child employee. Plus, you only need to file a federal tax return for your child if they meet the regular IRS rules for filing require them to file. (See Publication 929, Tax Rules for Children and Dependents for information on this.)

Picking a Job, Assigning Pay, and Keeping Records

When it comes to picking what job your child does, my advice is that there should be two lists of chores. First, the chores your child does because they are a member of the household. Second, the chores you are responsible for doing but for which you are willing to pay someone else to do.

Practically, this means I would recommend making a chore chart that makes clear who is responsible for which tasks first. Then after that is complete, talk about how anyone can pay to have someone else do their chores for them. You can then make your offer for the chores you are willing to delegate and see if any children are willing to do it. (Once your child has earned some savings, you can even allow your children to delegate their tasks to another sibling by letting them use their own money to pay for the task to be done.)

When setting a price, you should ensure that their hourly rate is similar to the going rate of someone outside of the family and is appropriate based on the child’s skill and value.

If you are looking for a fair benchmark, you might benefit from looking at minimum wage laws even though minimum wage laws do not apply to parents employing their own children. Right now, the federal minimum wage is $7.25 per hour and there is a special exemption that allows youth to be paid $4.25 per hour during their first 90 days of employment. On the other end, skilled laborers such as professional house cleaners might make as much as $20 – $40 per hour.

Also, you do not have to pay by the hour. You can pay by the task. Although it helps to have the hourly wage in mind. The thought process might go, “It’d take me 2ish hours to clean that bathroom. At just over $7 per hour, I would pay $15 for a clean bathroom.” This allows the very young to be inefficient without being rewarded for their slowness.

Whenever engaging in anything IRS related, the best protection is good records. Each time your child does a job, save and record:

when and/or for how long the child worked,
what task they were doing,
what they were paid,
when you paid them, and
how much of their pay was in cash.

The IRS says you need to “Keep your employment tax records for at least 4 years after the due date of the return on which you report the taxes or the date the taxes were paid, whichever is later.” However, we recommend keeping your records basically forever.

Roth IRA Funding

Once your child has earned the income, then your child is eligible for an amount of Roth IRA funding. There are many ways for you to get money into the Roth account.

First, the money that is contributed does not need to be the very same money they earned. Unlike a 401(k) plan, which requires salary deferrals in order to fund, you or anyone else can fund your Roth IRA with any money.

The child can contribute. Parents can contribute. Grandparents can contribute. A random friend can contribute. The only hitch is that you are limited in how much you can contribute up to their earned income or this year’s IRA contribution limit whichever is smaller.

If you want to maximize the amount that is put in while still giving the child a choice, one clever suggestion is that you or a grandparent could offer a Roth contribution match as gift. For example, every dollar the child contributes, you promise to also contribute one dollar. In this way, the child can save half of all their earnings as spending money while still getting the full allowable amount into their Roth IRA to grow tax-free.

This also provides early exposure to a real conversation they will have later in life when they are offered an employer match and asked how much they want to contribute to their 401(k) plan.

All in all, there are so many positive financial lessons that can be learned from this interaction, I highly recommend that you consider seeing if your family has any household jobs that are waiting for employees to fill them.

Re: Funding a custodial Roth IRA for children

Coolkids007 — Tue, 09 Mar 2021 22:52:55 GMT

@MaryM428

I appreciate you responding on this topic. I’m reviewing the IRS reference you provided above but I am unable pinpoint where it indicates that household chores are not considered as earned income for ROTH IRA.

Please help me find it.