Whoops, not so fast.
ESRBob said:
Thx, Nords'
It looks like the bulk of the effort is in the state tax area, and finding a fund family that will take on kids IRAs at reasonable fees. The Federal side of the equation looks fairly straightforward.
It looks like an incredible thing to do for your daughter, though. Especially since your low-stress ER lifestyle means you might live so long she'd need to wait 60 more years to get anything in the way of an inheritance from you guys. The Roth means she might just be able to ER herself one of these days, or have a good headstart on it. I feel like this sort of move is an everyman's version of what really rich parents do for their kids to keep them in club dues and yachts for life.
There may be another reason that this hasn't caught on-- the IRS.
I hate like hell having a good idea, nurturing it to fruition, researching the rules, applying logic to arrive at absolutely the correct result, and being shown that it'll never work for reasons that have nothing to do with rules or logic. Spock must feel like that when he's living with humans.
My BIL the CPA says the deal won't work. He's been doing accounting & taxes since high school and has worked himself up to partnership in a DC firm that handles a lot of high net worth customers. He's procesed W-2s with Medicare deductions in the six figures, seen plenty of stupid tax tricks, and gone through more audits than anyone should ever have to see. Most of the clients are tech entrepreneurs, sports stars, trust fund kids, and other people who love pushing the envelope but don't want to read IRS Pub 15. So I think that he knows what he's talking about and he has the experience to prove it.
He says that the IRS won't see a single rental property as a "sole proprietorship" business and that even if I meet the textbook definition of a real estate professional, I'm still not considered to be one. One rental property is apparently viewed as more of a hobby than a business (and we know how the IRS feels about deducting hobby losses). The RE professional definition is intended for the subject of deducting passive losses and not for determining whether I'm running a business. Two (preferably many more) rental properties and a realtor's license with self-employed income would be necessary for a CPA to feel that it appears "legit". He appreciates that I have the facts & definitions straight but he believes the IRS would immediately flag an audit when they put together the kid's W-2 and our tax return's Schedule E. Then the burden would be on us to "prove" that I'm a real estate professional... and adversarial relationships with the IRS are expensive. While the IRS won't normally waste their time chasing after one-property landlords, they might be happy to make an example of one who pissed them off in other areas. As much as I enjoy nuclear engineering, I don't want to spend the rest of my life producing increasingly detailed rental-property records.
An alternative would be to pay the kid for domestic employment (not chores!) using a W-2 & Schedule H. However my BIL doubts whether the kid could legitimately claim $4000/year income without raising another audit flag. (Gotta keep really detailed records for that one too, and again the judgment on that call rests with the IRS.) Although the concept could work at less than $4000/year, that also means paying high expenses for small IRA accounts. Essentially the legislative risk is way out of proportion to the possible reward, and again he's seen the audits to prove it.
But he likes hanging out at our house so he had another proposal. Many of his clients (who are advised by tax attorneys before he does their tax returns) just buy I bonds. It's a lower return (over the long run, probably a lot lower) and it's tax deferral, not tax avoidance, but it's a much lower legislative risk for the return. And of course if the kids have W-2 income from teenage part-time employment, then all of that W-2 income goes into an IRA. When the kid has "some" W-2 income then it's a lot easier to supplement it with $1000-$2000/year for domestic employment and thus max out the IRA contribution.
The huge risk reduction probably makes an I bond a better idea, too. $4000/year fits our annual college savings, so the kid's Roth IRA was going to fill that plan (which currently is funded by a UTMA). The UTMA is all equities (Berkshire Hathaway & Tweedy, Browne) so it's a good idea to put in a couple years of I bonds before the kid has a summer job. We could buy the I bond in our names as an educational bond (no tax) or just gift it to the kid for 30 years of tax deferral at her discretion. The UTMA is intended to be drawn down for college tuition & expenses (before age 21) so we could go either way.
Yeah, I know, no college aid. But we're beginning to think that an ER's retirement portfolio is drooled overseen by most college financial analysts as a huge resource to be dedicated to a child's college education, not as the assets backing a long-lived ER annuity. So while I'll probably fill out a FAFSA just for the sheer hedonistic thrill of it, I doubt we'd be seeing any grants and my UTMA/IRA/I-bond schemes wouldn't mess that up. I'm not sure I care to embark upon the loan process unless it has an incredibly low interest rate (we'll see about that in four years). But of course the kid will be chasing plenty of merit scholarships!
Your circumstances may be different than these, so if anyone else is planning to try this at home then consult a trained professional. For us the idea can work when the kid has "real" W-2 income, and in the meantime an I bond provides better diversification.
ESRBob said:
Looks like your mil training comes in handy for navigating the bureaucracy and forms, though. I think a lot of people would give up by the third form.
I did miss one bureaucratic step. Filling out a W-2 requires a federal employer ID number; it can't just be done with the boss' SSN.
