How to Pay Your Children
The Tax Court released a case earlier this week (Embroidery Express LLC TC Memo 2016-136) that provides very good advice on how to pay your children (or how not to pay them). As we have previously indicated, one of the best deductions for farmers is to pay their children under age 18 (for sole proprietors and husband/wife partnerships) wages of up to $6,300. The farmer is allowed to deduct these wages, the wages are usually tax-free to the child, there are no payroll taxes owed by the farmer or the child and the child can then put the wages into a Roth IRA.
However, as the Tax Court ruled, care must be taken in how the wages are calculated and paid. The taxpayers had various children involved in the business. They paid small amounts of wages during the year and then paid them a large bonus at year-end partially based on how well the business did during the year. There was no written documentation regarding hours or services rendered by the children.
The Tax Court ultimately ruled that the smaller wages paid during the year would be allowed as a deduction, however, the large bonuses paid at year-end were disallowed. The bottom line that farmers should follow in paying wages to their children is as follows:
- Document the hours worked by the children, preferably with some type of time card.
- Make sure the rate paid per hour is comparable with what you would pay outside third parties.
- If you are going to pay some type of bonus, make sure you have the plan in writing before the year starts and make sure it is reasonable for the services provided by the child.
- Make sure to follow state child labor law.
If you follow these rules, you and your child can save on income and payroll taxes and they can build up a good nest egg for college, etc.
Paul Neiffer, CPA
CliftonLarsonAllen LLP
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
Hi Paul. A quick question. You mention that if you pay your children, you do not have to pay payroll taxes. I agree with paying below the $6300 to claim the standard deduction, but how can you avoid the payroll taxes, if you run the payroll. I thought that was the cost. By keeping at $6300, the parents can get the exemption, and the child can have the $6300 and invest in Roth IRA. Thanks.