Pizza, Anyone?

Hiring your kids can save you taxes. If you hire your children, they are under 18 years old and your business is unincorporated, neither the business nor the kids have to pay Social Security or Medicare taxes on their wages. Shifting income to your children this way can also reduce your family’s income tax bill, because your minor children are likely in a lower tax bracket than you are. But remember: pigs get fat and hogs get slaughtered.

Patricia Diane Ross was a busy single mom with three kids, ages 15, 11 and 8. She had multiple unincorporated businesses that she ran from her home and her office. She said that she employed her children in her businesses and that they did age-appropriate office work. She prepared and filed Forms W-2 and other employment tax returns for her children.

When she produced evidence of payment of wages to her kids, Ms. Ross produced for the Tax Court credit card receipts for pizza and for tutoring services. She said that rather than actually paying her children directly, she bought things of value for them “at their direction.” Writing them a paycheck was just too much trouble, she said.

The Tax Court was not convinced that the kids were actually being paid for working in the business. The court could not recreate the hourly rate that Ms. Ross said she paid her children. For example, she said she paid the oldest child $10 per hour. The court calculated a rate of $30 per hour for 2007 and only $9 per hour in 2008. The amounts she was deducting seemed to have little correlation to the amount of work her children were purportedly performing. Most importantly, the Tax Court pointed out that a parent has a legal duty to support his or her children if able to do so and that feeding and educating one’s children is support. No deduction for Ms. Ross, just taxes.

So, be a pig, not a Patricia.




IRAs in the News this Summer

Individual Retirement Accounts (“IRAs”) are an important part of retirement savings for millions of people, including you, probably.  If I’m right about that, you should consider a couple of developments that happened this summer.  One addresses bankruptcy protection for inherited IRAs.  The other is about QLACs (see below).

First, in Clark et ux. v. Rameker, Trustee, et al., the Supreme Court ruled unanimously that inherited IRAs are not protected in bankruptcy under federal law.  This case involved a beneficiary who was the daughter of the decedent.  The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 provides that, as “retirement funds,” IRAs and Roth IRAs are exempt assets with a cumulative $1 million inflation-adjusted exemption (currently about $1,250,000 – $1,245,475 to be exact) and employer-sponsored plans with an unlimited exemption.  Basically, the Supremes said that inherited Individual RETIREMENT Accounts are not RETIREMENT assets for nonspousal beneficiaries under the Federal bankruptcy law.  Experts are divided on the application of the Clark decision to spousal beneficiaries.

Some states (including Texas) offer under their bankruptcy statutes expanded protection of inherited IRAs.  Don’t get too comfortable.  Do all your potential beneficiaries live in Texas or another state with expanded protection of IRAs?  Might they move?  In any case, you might check with your attorney.  While not a particularly tax-friendly solution, naming a trust as an IRA beneficiary may be a possible alternative to consider in some cases.

Second, on July 1, 2014, the Treasury Department published final regulations for qualifying longevity annuity contracts (“QLACs”).  Prior to the establishment of QLACs under the Treasury’s auspices, the fair market value of a non-annuitized IRA annuity  had to be included  in the prior yearend balance of IRAs when calculating required minimum distributions (“RMDs”) from traditional IRAs for folks who have reached 70 ½ years of age.  So, in a nutshell, you had to take out more of your IRA assets than you otherwise would/should, while you were protecting yourself from outliving your savings with a longevity annuity you might start to collect when you are 85 years old.  If that last sentence does not make much sense to you, you get the point exactly.  So did the Treasury.  Now, you don’t have to include QLACs in the prior yearend balance for computing your RMD.

There are a lot of rules governing QLACs and their structure.  Also, you can’t spend more than the lesser of 25% of your retirement funds (as defined) or $125,000 on QLACs.  Insurance companies will be providing a lot of products soon that will meet QLAC requirements.  If you think that these may be right for you, start by talking to your wealth adviser.