Tax Tip Thursday

Paying Your Kids

I have been dealing with a lot of small businesses right now, and that makes sense because the Sole Proprietor filing deadline is June 15. Since that is a Saturday, you actually have until midnight on Monday, June 17. As of Tuesday morning, if you owe money, penalties will kick in!

A Story of Write-offs

Business owners are always looking for ways to cut their taxes and here is one strategy that could or could NOT work for you!

This is a story of a small business owner who deducted $16,750 for wages their kids, got audited, taken to Tax Court, and lost.

We all have friends who tell us what we can “write off” if we have a small business. One of them is your kids!

There are You tube videos and various proponents of strategies that you can use to reduce your business income. Just keep in mind they will not be signing YOUR tax return.

Here is how one of those strategies was given and that a taxpayer followed to their demise.

Storytime

Christine ran a seamstress business. She saw a video online that said…. “You can pay each kid up to $15,000 per year tax free!”

Here’s how it works:

  1. Have a real business
  2. Make real money
  3. Hire kids for age-appropriate tasks
  4. Pay a reasonable wage for these tasks
  5. Formalize the employer/employee relationship like you would with any other employee
  6. Adhere to employment tax laws and the requirement to file informational returns

Some other things that were not mentioned that would help legitimize the transactions are:

  • Have job descriptions
  • Fill out time sheets
  • Have their business cards
  • Have their own phone lines
  • They must have their own bank account
  • Be paid into their own personal bank account

Her son, who was older than 18 at the time (important for Step 6), received $4,000 of wages from this business.

Unfortunately, the business failed to pay employment taxes on the $4,000.

She also failed to file a T4 for the payments to her son.

Interestingly, the $4,000 was paid in a lump sum before the son ever started working… as an “advance.”

How many business owners would do that in reality?

The Tax Court zeroed in on this advance citing that there was a lack of correlation between payments made and services performed.

On top of that, the Tax Court noted there was poor evidence of the hours actually worked by the son and that the son was performing family chores, such as cleaning the sewing room, moving boxes downstairs, and taking out trash.

Understandably, the Court disallowed the $4,000 payment.

But they weren’t done.

Christine also ran a dog breeding business.

And paid her two daughters $4,250 each in wages.

Her two daughters were not making much money and so no taxes needed to be deducted.

But the business was still required to file a T4 and failed to do so.

Additionally, the Court found it difficult to believe each daughter could earn exactly $4,250 and also receive that as a lump sum payment at the beginning of the year.

And again, the Court found most of the tasks to be family chores, such as walking dogs, cutting the grass, and cleaning windows.

What Went Wrong

Personally, I’m all for paying your kids to do real work in your business.

The typical problem with the strategy is that people always mess up steps 3-6.

I’ve seen people think their 7 year old is playing a material role in managing the parent’s rental portfolio. Or that it makes sense their 10 year old should be earning $100 per hour.

But even if you nail steps 3 and 4 and fail to follow-through on steps 5 and 6, you still lose.

Get them exposed at an early age to work, money, and financial management.

But…

If you are going to deduct the payments against your business income and call your kids “employees” then you must follow rules.

Cross your t’s and dot your i’s!

You can pay them, just make sure you do it the right way. If you’re not sure, book an appointment with us today and we can make sure you’re on the right track!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.