FROM THE TAX COURT – PUTTING YOUR KIDS ON THE PAYROLL

Another recent court case emphasizes the fact that it is vital that you keep detailed documentation of your deductions, regardless of what the deduction is.

John and Lisa Fisher, TC Summary Opinion 2016-10 deals with the deduction for wages paid by a parent’s company to minor children. 

The Fishers were lawyers with three children under age 9.  Lisa Fisher had her own law practice.

During the summer Lisa brought her kids to her office and had them do shredding, mailing, photocopying, and answer phones (to be perfectly honest, I would not have a child under age 9 answering my office phone or using a shredder).  She claimed a total of $29,000 in “wages to minor children” on her 2006, 2007, and 2008 Schedule Cs.

During these years Fisher did not keep any payroll records or issue W-2s to the children.  She did not actually give money to the children, either in cash or by check.  The “wages” were paid via contributions to 529 college savings plans for the kids.

The IRS disallowed the deduction, and the Court agreed because the Fishers did not substantiate the deduction via proper documentation.  The Court could not determine the actual amount paid to each child each year because there were no records of the hours worked or the rate of pay.

Surprisingly, the Court felt that the children actually did some work for Fisher and allowed a deduction of $250 per child per year.

The moral of the story - as I point out in my book AN INTRODUCTION TO SELF-EMPLOYMENT: THE BASICS OF SCHEDULE C - is: 

“It is very important that you “cross your t’s and dot your i’s” when it comes to documenting a deduction for dependent wages. You must make sure you pass the “duck test” (if it waddles like a duck and quacks like a duck . . .). Forget that these are your kids and treat them as you would any other employee.

• Create a written job description for each position held by your child outlining the duties and responsibilities involved.

• Pay the kids on an hourly basis.

• Use a time card or sheet to document hours worked and work performed.

• Write a company check as payment each week or every-other week.

• Even though the wages are not subject to FICA and FUTA tax and possibly state unemployment and disability contributions, file all appropriate quarterly payroll tax returns, such as the federal Form 941 (you can indicate that the wages are exempt from FICA on the form), submit an annual federal Form 940 indicating the amounts paid as “exempt”, and issue a W-2 in January to report the wages paid.

• If you have other employees make sure the kids’ wages are included on the quarterly and annual payroll tax returns.”

As an aside, I have always wondered why the IRS in their attempts to “control” all tax preparers felt that lawyers did not have to take any tax test or maintain any tax CPE to indicate to the Service and the public that they know anything about preparing federal taxes, and this case is a good example that many do not.

TTFN