Tax filing requirements for children with 1099-NEC

[SriniVenkat]

My children ages 11, 13 and 19 (as of Dec 31 2020) did some work for my education business (S-Corp) in 2020.

I compensated them $1000, $1500 and $2000 respectively and issued 1099-NEC for each of them. They did not have any other income.

1. Do I need to file tax forms for each of them?

- If yes, what form should I use?

- what would be the tax liability? Is there a penalty for filing only by Sept 15th?

- can I still claim them as dependents on my tax form?

2. Can I include their income in my 1040 tax return?

- Do I just include their 1099-NEC amounts like I do with my/my spouse's income?

- Do I then pay highest bracket taxes on those amounts?

- Is it any different treatment for my minor kids vs 19 year old?

Is there a better way of handling such payments to children in future years?

Thank you!

[VolvoGirl]

Sorry, yes they each need to file a tax return for self employment income and pay self employment tax on it.  You can still claim them as dependents on your return.  You do not report their income on your return.

To file a separate return for a dependent you need to set up a new account.  Online is only good for one return per account.  You can use the same email address for 5 accounts.  You can probably use the Free Edition or the Free File website

Https://ttlc.intuit.com/questions/1894512-how-do-i-start-another-return-in-turbotax-online 

Be sure on their return you check the box that says they can be claimed on someone else’s return.  

[VolvoGirl]

There won't be any regular income tax due on those low amounts but they will owe about 15% self employment tax on it.

They will have to fill out a Schedule C in their 1040 return.  Self Employment tax (Scheduled SE) is automatically generated if a person has $400 or more of net profit from self-employment.  You pay 15.3% SE tax on 92.35% of your Net Profit greater than $400.  The 15.3% self employed SE Tax is to pay both the employer part and employee part of Social Security and Medicare.  So you get social security credit for it when you retire.  

In case I wasn't clear they each need to file a tax return.  You might consider using the Desktop CD/Download program.  It can do unlimited returns and efile 5 for free.  Buy the personal Desktop CD/Download programs here

https://turbotax.intuit.com/personal-taxes/cd-download/

[Opus 17]

A child always files a tax return in their own name for income earned from working.  Sometimes if a child's only income is from investments, it can be reported on a parent's tax return.  The child will not owe income tax if their income is less than $12,400, but they will owe self-employment tax (15% of net income after expenses).

Whether the child is your dependent depends on the usual tests, it doesn't specifically matter that you paid them.  The tests are here. 

https://www.irs.gov/pub/irs-pdf/p501.pdf

Very briefly, the 11 and 13 year olds are your dependents as long as they lived with you and did not provide more than half their financial support.  The 19 year old is your dependent if was is a full time student for at least part of 5 months (such as the spring go his senior high school year), and he lived with you and did not provide more than half his support.  If he was not a full time student, he is only your dependent if his total taxable income (from all sources) was less than $4300 and you provided more than half his support. 

[Hal_Al]

You should issue them  W-2, not 1099-NEC.  That way, none of it is subject to Self employment or FICA tax, if you are a sole proprietor (Schedule C). 

Furthermore, then, they do not file a tax return because the  filing threshold for a dependent, with earned income, from wages, is $12,400 They can still be your dependent.

You must issue her a w-2. If she is under 18, you do not have to withhold FICA. You should not give her a 1099-NEC.

Reference: https://www.irs.gov/businesses/small-businesses-self-employed/family-help

distributions shown on a 1099-DIV, 

[Opus 17]

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@Hal_Al wrote:

You should issue them  W-2, not 1099-NEC.  That way, none of it is subject to Self employment or FICA tax. 

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Well, I would still say that is dependent on the worker-employer relationship.

https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-o...

It is true that if the children are classified as employees and paid on a W-2, the parent-employer does not have to withhold and pay FICA, FUTA or Medicare tax, which means the child's tax will be lower than if they are paid on a 1099.  It's probably too late to change this for 2020, since canceling the 1099s and issuing late W-2s could raise red flags.  The children could be paid as W-2 employees for 2021.

However, you would also need to follow all state laws that apply to employees, unless there are exceptions for one's own children.  Such as minimum wage laws, laws about insurance and other benefits, hours allowed to work, and so on.  For example, in NY, an employer must provide a pay statement that contains 13 or 15 specific pieces of information, and the fine for failing to provide a conforming pay statement is $100 per employee per paycheck.  You might be required to pay a state minimum wage, or follow number of hours worked limits, or get permission from the child's school district (a work permit).  A family employer might or might not be exempt from these laws with respect to their own children.  

Make sure you know the rules and limits before you hire your children as regular employees.  

[AmeliesUncle]

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@Hal_Al wrote:

You should issue them  W-2, not 1099-NEC.  That way, none of it is subject to Self employment or FICA tax. 

Furthermore, then, they do not file a tax return because the  filing threshold for a dependent, with earned income, from wages, is $12,400 They can still be your dependent.

You must issue her a w-2. If she is under 18, you do not have to withhold FICA. You should not give her a 1099-NEC.

Reference: https://www.irs.gov/businesses/small-businesses-self-employed/family-help

distributions shown on a 1099-DIV, 

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(1) You are almost certainly right that the children are employees, not Independent Contractors.  The determination is a matter of fact, not choice.  And having your children work for you would almost certainly be employees.

https://www.irs.gov/newsroom/understanding-employee-vs-contractor-designation

https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-o...

(2)  However, their wages ARE subject to payroll taxes.  The exemption for payroll taxes do not apply in this case because they are working for a corporation (the OP said it is an S-corp), not the parent.

[Hal_Al]

@AmeliesUncle  is correct.  Even though an S corp is a pass through entity, for income taxes purposes, it is still a corporation for employee payroll purposes.  The underage children do not qualify FICA exemption.  I've revised my answer above.

Here's a possible workaround:  https://wealthfactory.com/articles/how-to-avoid-payroll-tax-for-your-children-if-your-business-is-an...