Paying Your Child A Tax-Deductible Allowance

A favorite tax-planning tactic is to have a minor child work for the family-owned business. Income earned by the child is taxed at the child’s tax rate, which is likely to be much lower than the parents’ rate. In addition, the company gets a deduction for the child’s salary. A dramatic taxpayer victory* shows just how effective this tactic can be.

The facts: The taxpayers owned a mobile-home park and hired their three children, aged 7,11, and 12 to work there. The children cleaned the grounds, did landscaping work, maintained the swimming pool, answered phones, and did minor repair work. The taxpayers deducted over $17,000 that they paid to the children during a three-year period. But the IRS objected, and the case went to trial. Court’s decision: Over $15,000 of deductions were approved. Most of the deductions that were disallowed were attributable to the seven-year-old. But even $1,200 of his earnings were approved by the court.

Key: The children actually performed the work for which they were paid. And the work was necessary for the business. The taxpayers demonstrated that if their children had not done the work, they would have had to hire someone else to do it.