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Kids & IRAs.
Old 04-06-2005, 08:13 AM   #1
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Kids & IRAs.

Just finished our tax return and now it's time to start on the kid's. Since I'm in classic hypercaffienated work-avoidance mode, it's probably better to post this pondering than to waste an hour on Solitaire.

I'm suspecting that the IRS is not making it easy to figure out how to do this, but now that our kid has discarded dressage we have some budget room to fund her IRA. (Let that be a warning to other parents the next time your toddler says "Look Daddy, HORSIES!")

I understand that this should be one's lowest savings priority after home, retirement, college, infrastructure replacements, & so forth. That's already in the budget. We're not impoverishing ourselves to give our kid a higher standard of living; spouse just happens to be finding plenty of work this year and we're only pointing the discretionary spending in another direction. (I'm not putting any more money in Nortel stock.) But we're also compelled by the prospect of four or five decades of compounding power, especially when the contributions can be withdrawn without penalty for unforeseen expenses (like more college, or caring for your elderly parents).

So how does one bequeath up to $4000/year of earned income upon one's progeny? She could arguably perform up to $333.33/month of child labor on the rental property or helping with home improvement projects. Do we property managers have to issue a 1099-MISC or a W-2, or is it just included on our Schedule E and the kid's 1040? Do we pay Social Security or other payroll taxes? Is this an IRS audit red flag? Anyone doing this with their kid(s)? Is there a website, a book, or an IRS pub that we can reference? Any other lessons learned?


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Re: Kids & IRAs.
Old 04-06-2005, 09:13 AM   #2
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Re: Kids & IRAs.

I opened Roth IRAs for my kids when they were about 15 or so. Their earned income was from babysitting, mowing lawns, etc. I filed a tax return to support the amount put in the Roth IRA and IRS send me a postcard letting me know that the income was below the threshold and no Tax return was necessary.

So I left it at that.
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Re: Kids & IRAs.
Old 04-06-2005, 09:59 AM   #3
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Re: Kids & IRAs.

Since i think the chances of me outliving my kid is relatively low, my IRA for him will be my estate. That should be more than enough, at least for my contribution to him.
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Re: Kids & IRAs.
Old 04-06-2005, 10:37 AM   #4
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Re: Kids & IRAs.

Here's something similar to what KB said:

http://moneycentral.msn.com/content/...15.asp?Printer
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Re: Kids & IRAs.
Old 04-06-2005, 03:57 PM   #5
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Re: Kids & IRAs.

Thanks. I hadn't considered the exemption on SS for the under-18 crowd. (I don't think it was that way when I had a high-school job!)

I particularly like the idea of issuing a W-2 (to document the earnings) and then having it wiped out by the standard deduction. I also think this beats the heck outta 529s and Coverdells while offering much more flexibility...
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Re: Kids & IRAs.
Old 04-06-2005, 07:14 PM   #6
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Re: Kids & IRAs.

Quote:

So how does one bequeath up to $4000/year of earned income upon one's progeny?
Nords,

I think I remembered reading where you do NOT have to issue a W2 to an employee (child or adult) IF the total earned wages are less than $600/year. I'm not positive on this, but it might be an easy way to get her to earn at least that much without much hassle/documentation....

--Peter
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Re: Kids & IRAs.
Old 04-07-2005, 01:06 AM   #7
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Re: Kids & IRAs.

I don't know about W-2s (yet) but that $600 limit applies to 1099s.

I have a lot of reading to do...
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Re: Kids & IRAs.
Old 04-07-2005, 08:09 PM   #8
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Re: Kids & IRAs.

Quote:
Here's something similar to what KB said:

http://moneycentral.msn.com/content/...15.asp?Printer
Wow, Soup, thanks for this link.

I really think this one has legs. I was intrigued, btw, by the assertion that the kid has an exemption, but that since you give more than 50% of the kid's support, you can also continue claiming the kid as an exemption. In my mind, that is the key to making the whole thing work-- it is what provides the shelter on the kids income. Does this sound right to everybody?

But even unsheltered, getting your kid a Roth is a great legacy to give them.

One son 9, the other 13. Time to get cracking!

If anybody hears any thing casting doubt on the merits of this plan, or giving it more credence, pls let us know.
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Re: Kids & IRAs.
Old 04-07-2005, 08:46 PM   #9
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Re: Kids & IRAs.

The guy that wrote that article makes it sound like he invented something new and he's taking credit for it.

It's a strategy that's been around for decades.

He's definitely an amateur by the way he writes and he does make a few mistakes in his article, but generally he is correct.
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Re: Kids & IRAs.
Old 04-08-2005, 08:03 AM   #10
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Re: Kids & IRAs.

just curious - what mistakes?
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Old 04-08-2005, 09:01 AM   #11
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Re: Kids & IRAs.

Quote:
just curious - what mistakes?
For one, he says "Similarly, you could give the money to your child as a gift, but any income that's earned is taxed at the parent's marginal tax rate until the child is at least 14 years old. "
Not true. It's taxed at the parent's marginal tax rate only if the investment income is over $1,600. And then, only the amount over the $1,600 is taxed at the parent's highest marginal tax rate.
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Re: Kids & IRAs.
Old 04-08-2005, 02:03 PM   #12
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Re: Kids & IRAs.

Quote:
I was intrigued, btw, by the assertion that the kid has an exemption, but that since you give more than 50% of the kid's support, you can also continue claiming the kid as an exemption.
The kid gets an exemption while you get both an exemption and the deduction.

(I'm only conversant enough with the vocabulary to handle these questions in the 30 days before April 15th.)

You know that one kid chews through far of your support than a measly $4000 IRA contribution! With two kids is it squared or cubed?
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Re: Kids & IRAs.
Old 04-08-2005, 03:18 PM   #13
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Re: Kids & IRAs.

It just seems odd to me that the kid gets his own exemption, for earned income and you get to claim him/her for another exemption on your taxes. Each one of these exemptions shelters $3100 so I wouldn't think they'd just give them away. But if it is true, then the whole scheme has legs.

Am I right that you would only get to deduct the payments you made to your kid if you run a profit and loss business (Schedule C) that attempts to make a profit, and you are able to pay the kid to do legitimate services to that company?

Or can you have him 'clean your home office' or some such?



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Re: Kids & IRAs.
Old 04-08-2005, 05:20 PM   #14
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Re: Kids & IRAs.

Quote:
The kid gets an exemption while you get both an exemption and the deduction.

(I'm only conversant enough with the vocabulary to handle these questions in the 30 days before April 15th.)
Not conversant enough :)

The kid gets to use his standard deduction while you get to claim an exemption for the kid. You can't double dip on exemptions.
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Re: Kids & IRAs.
Old 04-08-2005, 08:22 PM   #15
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Re: Kids & IRAs.

Even with the kid's standard deduction, my accountant is in the process of showing me that this isn't as good as I'd originally thought:

Basically, he says it would only really work if you were self-employed, meaningfully profitable, in a high tax bracket yourselves, and already had employees (payroll system in place).

Otherwise, he reckons you and the kid spend about 50 cents for each dollar you are able to get into the IRA, what with the self employment tax the kid pays, (15%) and medicare and so forth, plus this might push the kids other investment income, if any, into higher brackets, and then there is the several hundred dollars a year to have a payroll service or accountant file the paperwork for all the W2s and quarterly filiings etc. In the end, he just doesn't think it would work well for me, though, again, a self-employed person with meaningful income and infrastructure in their company could add this on with little extra effort and have all the costs deductible.

My take away is that it is all about the details of you and your kids' relative tax rates and situations, and not something that can be blanket applied especially for those in ER with little or no earned income and little or no income taxes.
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Re: Kids & IRAs.
Old 04-08-2005, 08:36 PM   #16
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Re: Kids & IRAs.

Quote:
...with the self employment tax the kid pays, (15%) and medicare and so forth
Who said the kids pay self-employment tax on their wages? They don't.
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Re: Kids & IRAs.
Old 04-09-2005, 10:36 PM   #17
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Re: Kids & IRAs.

Quote:
Basically, he says it *would only really work if you were self-employed, meaningfully profitable, in a high tax bracket yourselves, and already had employees (payroll system in place). *

Otherwise, he reckons you and the kid spend about 50 cents for each dollar you are able to get into the IRA, what with the self employment tax the kid pays, (15%) and medicare and so forth, plus this might push the kids other investment income, if any, into higher brackets, and then there is the several hundred dollars a year to have a payroll service or accountant file the paperwork for all the W2s and quarterly filiings etc. *In the end, he just doesn't think it would work well for me, though, again, a self-employed person with meaningful income and infrastructure in their company could add this on with little extra effort and have all the costs deductible.
Maybe your accountant's kids are too old.

First, and I need to confirm this by researching the IRS pubs, kids under 18 don't pay SS or Medicare taxes.

Second, we're talking a $4K IRA contribution which is well below the standard deduction.

Third, I wouldn't have to pay anyone for paperwork. Learning how to do my own 1099-MISCs for a small non-profit only took a couple hours of research. It actually took longer to swear at Quickbooks' stupid data-entry system than it did to figure out the IRS rules. I suspect W-2s won't be much harder. And there won't be any estimated payments or associated paperwork.

Finally, this is a way to shelter $4K a year from taxes with the returns growing tax-free. It'll go into a Fidelity brokerage account and it'll be invested in a small-cap value index like the S&P600/Barra Small-cap Value ETF (IJS) for an $8 commission , 0.25% ER, and free dividend reinvestments. (Admittedly I'm not sure about Fidelity's custodial rules for minors' brokerage accounts, but our balance is probably big enough to put them in a cooperative mindset.)

The result is an investment that'l cost $18 bucks the first year and roughly $10-12/year for the next several years. It won't be my money anymore but that's still better than a UGMA (with its potential taxes). It won't be restricted to educational purposes and it beats the heck outta 529 costs or the Coverdell limit. The contributions can be withdrawn tax- and penalty-free (e.g., for college expenses) and the returns can also be withdrawn to pay for a first-time home purchase.

Where's the catch?
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Re: Kids & IRAs.
Old 04-10-2005, 04:19 AM   #18
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Re: Kids & IRAs.

I agree with Nords, and I would add that there is a lot
of gold in similar situations if you do your homework.
I already have the corp. in place, but am so lazy that
I won't dig and ponder as everything works smoothly
now and I don't want to complicate things. I am quite
certain there is money to be made (saved) there, but
I would need to ferret out the ways and then it would mean more paperwork. Bah humbug!

JG
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Re: Kids & IRAs.
Old 04-10-2005, 12:04 PM   #19
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Re: Kids & IRAs.

http://fairmark.com/rothira/minors.htm



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Re: Kids & IRAs.
Old 04-10-2005, 07:56 PM   #20
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Re: Kids & IRAs.

Quote:
Who said the kids pay self-employment tax on their wages? They don't.

Will get to the bottom of this this week, but I probably misspoke about SET -- still, doesn't the child need to pay a regular SS/Medicare/FICA withholding, and you, the employer, pay the same on the employee's behalf, meaning that together, the two halves would equal the SET in dollar amount?

Or are you saying a child earning a small amount of income would not need to pay SS/Fica/Medicare at all? If not, why not?

Nords, the concern about hassle my accountant had, (remember, this was first blush look the week before 4/15 -- he promised to look this over in more depth during the coming days), was filing the payroll taxes with the feds. If that turns out to be moot, then agreed, that cuts out most of the hassle factor.

In my case the kids have other unearned income from other moneys we have given them, and he was concerned that the additional salary income would push them into higher brackets for this other income, which was where I started to get discouraged.

The link above to Fairmark suggests though that home chores will never be earned income, so that at least is out. Taking care of your rental property sounds good, though!
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