Can I claim my child as a dependent if they work?

[Rosalyn2010]

OK I know this is a silly question but hear me out.  My son is 9 and I want to write him a check for doing yardwork and put the wages into a Roth IRA account for him.  Now he will only be getting paid $25/month for the doing the yardwork.  I guess there are a couple of parts to my question.  How do I document it on my taxes that I employed him to do such work?  Will he have to pay taxes on these earned wages, will he have to file taxes for making $300 for the year? Should I withhold anything from his check. Like if I am paying him $25 for the work should I only write the check for $20? What records do I need to keep? Any information will be appreciated. 

[DanPaul02]

No to all of your questions an no to this being earned income for a Roth IRA.

[Rosalyn2010]

What qualifies as earned income, because everything I google says if I pay him it is earned income. If I have a T-shirt Business and he helps me with cleaning (janitor) and I pay him $25/month would that count as income?

[Opus 17]

You would have a household employee.  You are not required to pay household employee tax or withhold social security when the employee is your child under age 21.  You are not required to withhold federal income tax.  As long as you don't withhold federal income tax and you don't pay household employer tax, you are not required to issue a W-2.

https://www.irs.gov/taxtopics/tc756

If you want to issue a W-2 so the "wages" are documented, you must first get an EIN, employer ID number.  You don't use your SSN as the payor if you pay wages.

If you don't issue a W-2, your son can file a tax return by including the wages and noting "HSH" on line 1 next to the dollar amount.  Turbotax has a place under "other uncommon income" to report household employee wages.  If the wages are less than $4300, he would not be required to file a return at all.

I think a more important question is whether the IRS would view this as a sham to turn an allowance into "compensation" for purposes of the IRA contribution.  I would feel a lot happier about your son earning $25 for cutting the neighbor's grass and reporting as schedule C self-employment income, rather than being paid by his parents.  You may be taking a risk here, and while $300 per year is probably not worth paying for a professional opinion which might cost $300, the situation seems like a vulnerability to you.  

(Then I would ask, if these really are "wages", are you subject to your state laws regarding minimum wage, child labor, hazardous occupations, and so on.  Are you creating another legal vulnerability.)

[VolvoGirl]

To count as earned income he has to have a net profit of $433 or more on schedule C for self employment income.  It needs to be at least  $433 to pay self employment tax on it.  You need to pay self employment tax to count as earned income.  

Then, If you have self-employment income you can only contribute to a IRA up to your net profit reduced by the deduction allowed for the ER portion of your self-employment taxes. See IRS publication 590A (page 39 for ROTH) https://www.irs.gov/pub/irs-pdf/p590a.pdf 

[Opus 17]

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@Rosalyn2010 wrote:

What qualifies as earned income, because everything I google says if I pay him it is earned income. If I have a T-shirt Business and he helps me with cleaning (janitor) and I pay him $25/month would that count as income?

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How do you prove this is wages, rather than a sham transaction to be able to put his allowance into a Roth IRA?

For one thing, the IRS would look at whether you are paying fair market rate.  I expect hiring a lawn service to mow your lawn would be $40+ per week.  What services are your child actually performing for $25 per month?  Is your child actually old enough to materially perform a service for wages (mature enough, physically capable, etc.).  Would you hire your neighbor's 9-year old child to perform the same tasks for the same wage, if your son was temporarily disabled, or on vacation?

If you did hire your child to clean up a t-shirt business, for example, you would probably be expected to follow state labor laws including minimum wage and child labor laws.  Sometimes those laws don't apply to family, sometimes they do.  How does your state labor laws view a 9-year old handling dangerous tools (lawn mower, shears, pesticides, etc.)?

It's much easier with a third party.  If the neighbors hire your son to mow the lawn, it's a hands off transaction from your point of view.  And you could give him gifts equal to his taxable compensation to deposit in the IRA.  And once your child has a job of their own (age 14 or younger, depending on the state and the type of job) you could easily gift your son an amount equal to his wages to put into his IRA.

But for now, this looks like a sham to put an allowance into the Roth.  If audited, I think you would have problems.  

[Critter-3]

@Rosalyn2010 

If you have a business that has an existing  payroll then you can pay your kids under the age of 18 if they actually do some work at the business  that you can pay them for  and put the earnings into a ROTH ... this is a good tax planning idea.  However you must issue a W-2 at the end of the year and keep good records of the work done & paychecks paid if you are ever audited.  

Children under the age of 18 are exempt from FICA taxes and if you keep the income below the standard deduction it will be tax free for the feds ... check your state rules as they may differ. 

[Opus 17]

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@VolvoGirl wrote:

To count as earned income he has to have a net profit of $433 or more on schedule C for self employment income.  It needs to be at least  $433 to pay self employment tax on it.  You need to pay self employment tax to count as earned income.  

Then, If you have self-employment income you can only contribute to a IRA up to your net profit reduced by the deduction allowed for the ER portion of your self-employment taxes. See IRS publication 590A (page 39 for ROTH) https://www.irs.gov/pub/irs-pdf/p590a.pdf 

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I don't believe that "taxable compensation" for purposes of a Roth IRA is the same thing as "earned income".  There's nothing in pub 590-A that says household employee wages (HSH on line 1) can't be taxable compensation, and worksheet 2-1 would allow line 1 HSH wages to work for a Roth.   And there are several other kinds of "taxable compensation" that are not earned income.

The important question is whether the IRS will view this as a sham. 

[macuser_22]

I agree with Opus 17 - This sounds like an allowance that you are attempting to call something else in order to put it in an IRA.    This might work in the short term but if the IRS questions it then the IRA can be disqualified with large penalties.

[Mike9241]

I think the IRS would view this as a sham. after all your son isn't paying you for the value of the food and shelter you are providing him.   if the IRS were to view this as a sham, there would be penalties for excess contributions to the Roth.  you too could face penalties for preparing a frivolous return.