Therefore,
a child who earns $4,000 baby-sitting and has no interest or dividends is not
required to file a tax return. However, if you wish to take a $4,000 deduction
for a regular IRA, or contribute $4,000 to a Roth IRA, it is our recommendation
that a tax return be filed. The return is proof that the child qualified for an
IRA (earned income requirement).
When
filing the tax return, record $4,000 (or whatever income is earned) on Schedule
C-EZ. The net income is then carried to Line 12 on page one of Form 1040. If the
child is contributing to a Traditional IRA, take the IRA deduction on page one,
Line 24. If the child is contributing to a Roth IRA, there is no form to complete.
Self-Employment Tax must be paid on
self-employment income. Self-employment income is "gross income derived from
any trade or business carried on as a sole proprietor."
***Note:
Self-employment tax is never required on a dependent's earned income if that income
is received from a parent.
We at The
Henssler Financial Group maintain that mowing lawns or baby-sitting by a young
person, who is still a dependent of their parents and still in school, is not
performing a service as their trade or business, and is not subject to self-employment
tax. The Henssler Financial Group has filed tax returns for children with baby-sitting
income. No self-employment tax was calculated, and these returns have not been
challenged. The tax court has affirmed this position - that a baby sitter, who
is under the control and direction of the children's parents, is not subject to
self-employment tax (Hodgkinson vs. Commr, TC Memo 1968-176, 27 TCM 865). We concur
with this position, and maintain that dependents, who mow lawns, wash windows,
tidy the house, etc., are not subject to self-employment tax.
All
W-2 income is earned income, and if received, allows the individual to make an
IRA contribution up to $4,000 (or their earned income, whichever is less). For
parents with sole proprietorships, you might consider hiring your child and pay
them through payroll. The children are exempt from social security, Medicare tax,
state and federal unemployment, if they are under the age of 18. This is not the
case if the parent operates their business as a corporation, partnership or other
entity. Under these circumstances, the child is not exempt from employment related
taxes.
This should clarify the eligibility
requirement for funding your child's IRA. By the way, this works for grandchildren
as well. For more information regarding this topic, please contact The Henssler Financial Group at 770-429-9166 or comments@henssler.com.
