All in the Family: Put your kids to work

By Joseph N. DuCanto
Schiller, DuCanto and Fleck

To paraphrase “W,” no kid should be left unemployed.

School may or may not be more difficult these days, but there’s no doubt that the “kiddie tax” has become even more taxing. No longer does it stop at taxing the passive income of children less than 14 years old at their parents’ highest marginal rate.

The depressing truth is that in 2006, the kiddie tax increased its amplitude to include all children up to age 18.

In 2007 the tax hammer fell once again, raising the applicable age to 19 - or more. The kiddie tax now also is a “smartie tax,” if the “kiddie” is a full-time student up to age 24, fails to earn enough to provide more than half of his or her own support, and is the parents’ not-so-bouncing baby exemption.

Perhaps this is the opposite of “no child left behind”.

This time it means “no child gets ahead.” These mean-spirited directives prevent wealth-building by the young.

This legislation springs from a basic assumption that inter-generational wealth transfer from parents to their young children is a pernicious device used by senior family members solely to escape taxation on their lofty income.

Baloney.

Most of us are not Rockefellers or rock stars. But we also get hit, and our children suffer for it both now and in the long run, because the kiddie tax is extremely short-sighted.

Teaching youngsters the value of saving and the judicious use of their money is a worthwhile endeavor and ultimately produces financially intelligent citizens.

Reality intrudes, however, and one asks, “What’s a parent to do?”

Be smart.

If you are a business owner or a professional, hire your kid! It’s not only desirable, it’s legal.

In some instances, the age limitation for child labor is lower for family members working in a family enterprise than is generally applicable to unrelated employees. It is thus possible for a business owner to shift some of her highly taxed income to her 16-year-old daughter who works full-time during the summer and part-time while in school, assisting with routine office work, reception, and related jobs.

Such additional temporary help is often completely justified by using the child to
fill in for vacationing full-time, unrelated employees.

Assume an Illinois mother has a 38 percent tax burden, including state taxes. Assume further that she employs her child for $9 an hour for 12 weeks, resulting in a gross income of $4,320 for the child.

Now add a 10-hour-per-week part-time job for 30 weeks during the school year, adding another $2,700 to the child’s income, and totaling $7,020 for the year.

Such earned income is not subject to the kiddie tax since that tax relates only to investment income. Additionally, while the child is still claimed as a dependent by her mother, the child may nonetheless use her 2008 standard deduction of $5,450 to shield her income from taxation.

Before April 15, 2009, this fond and doting mother gifts the child with a contribution of $5,000 to the daughter’s newly established Individual Retirement Account.

Despite receiving the IRA funds as a gift, the child may nonetheless still claim the IRA deduction as an income offset for taxable year 2008, completely shielding all of her income from any tax, including FICA, which does not tax income of a child under 18 while the child is employed by a parent.

Consider here that the mother has indelibly impressed upon the child the necessity of maintaining the IRA over future years.

This is a great lesson in thrift and the miracles of tax-free compounding.

Mother is able to demonstrate that daughter’s continuation of the $5,000 per year contribution for 50 years, at an average growth of 7 percent compounded annually, produces an astonishing end fund of $2,032,645! How can one resist the logic of use of this major wealth-building strategy?

In summary, Mother has successfully shifted an avoidable tax burden of $2,668 (38 percent of $7,020) to the daughter and is financially “out” only $2,332 after gifting the IRA contribution to the daughter, who now has a head start on a lifetime of wealth-building and financial planning.

And, when the daughter receives a tax refund in 2009, reflecting a return of taxes withheld from her weekly wages, she will
get a big lesson on the impact of taxation in American life.

The scenario is not a sleazy game but a perfectly legitimate use of good financial-tax sense.

The job is real, is actually performed by the child onsite, and is justified by the needs of the business.

Perhaps, you say, Mother would not have hired someone from outside the family to provide these services; but then, as all parents will attest, “charity” begins at home.

Take THAT, Uncle Sam.