IRS is pretty strict about what you can pay your kids for. In a tax audit, paying an 8 year old 10k a year may seem hard to justify. But I think I have a case with my 8 year old Mini Wise Money (MWM).
Moneywise, it makes sense to pay Mini 10k, deduct her pay from Dr. Wise Money LLC business income, let MWM file and pay her own taxes, and then fund her own Roth IRA. Not only is MWM’s 10k AGI tax rate way lower than mine and that of DWM LLC, but also it is likely the lowest tax bracket MWM will ever enjoy going forward. Both Mini’s income and the tax rate are bound to increase as she gets older.
As many of you know, MWM is a gifted artist. Here’s a piece of oil-painting she completed in 9 hours, over 3 Sundays as a 4 year old. Her art teacher, taught a group of 15 5 to 13 year-old, MWM got in this group class because I convinced the teacher she was a very well behaved 4 year old.
Her art teacher loved MWM so much that when I went on residency interview trail, she offered to take MWM off of her dad’s hand. She joked she would adopt MWM if she could.
Many people have offered to purchase MWM’s artwork, but parents, grandparents are not willing to part with MWM’s original art pieces. Hence MWM has only sold replica so far, but she has sold one original sculpture to my company DWM LLC at $300, and that’s with a generous discount (which Mini called mommy discount.)
MWM has generously displayed her artwork in galleries on drwisemoney.com. So for that, she’s getting compensated for $1500/year. Additionally, you noticed her pictures throughout many of my blog posts and even published on Physicians’ Money Digest. For her modeling work, she gets $1500/year flat fee.
We recently moved into our dream home (the second home I purchased in 2 years). We kept the first home in our family and got this dream home for MWM, my parents, and myself. As soon as the seller signed our purchase contract, MWM started planning parties and summer camps.
I was going to hire a professional party planner for MWM’s 9th birthday, but to my great surprise, Mini rose up to the occasion with quality-work that beats the professional I was going to hire. The tear-jerking party invitation letter (which really was an essay) and the party schedule (planned down the minute) certainly would have taken me more than 4 hours to produce (which is worth $388/hr x 4 to me.)
So MWM deservedly earned herself $1500 orchestrating her own 9th year old birthday party. See below for her party invitation letter, and the party schedule. I would definitely hire MWM for future company parties and events. Since at this party, we will be entertaining & feeding business associates and conducting business meetings for DWM LLC, we can definitely justify paying MWM from the DWM LLC. So it’s definitely wonderful that I am not paying personally, but my company DWM LLC is paying Mini for this company event/birthday party. When I pay Mini, it’s post-tax dollars. When DWM LLC pays Mini or me, it’s pre-tax money.
[Johanna CPA says: What DWM means by this is that, as an individual, there is no ordinary and necessary “business purpose” for taking a tax deduction for payments to MWM. However, she believes there is justification to deduct payments to MWM through DWM, LLC as ordinary and necessary business expenses.]
Back to MWM’s talent and hobby in art. She is designing and making our DWM LLC company uniform. The art supply and raw materials would be deducted from DMW LLC. Furthermore, MWM makes $500 for her creative design of the company T shirts. Then she gets $30/shirt purchased. I’m buying 40 shirts for business associates and volunteers. She made another $1200 here. We’re now at $6500.
Do you notice how many posts/articles I write are about MWM? She’s my think tank and creative juice. For every post she helps me generate, I started paying her $50 on 1/1/2016. Then I realized MWM was involved in so many posts that it was getting expensive, so we negotiated a fair deal after we discussed DWM LLC’s balance sheet.
Mini gets $2500 flat fee for the year of 2016 regardless of how many posts she help me generate. It’s already saving me money, as I have written more than 50 articles inspired by her this year, not counting all the other ones from prior year when MWM worked for future earnings. $9,000.
While I can’t exactly justify Mini’s equestrian lessons as DWM LLC company expenses, I could certainly justify her art lessons as furthering employee education. Since she directly benefits DWM LLC with her digital art gallery contribution on drwisemoney.com, time she spends on improving her art skills are compensated. MWM, voluntarily on average spends 15 hours per week watching art/DIY videos and creating new art pieces: 1-2 hour on each week day; 5-8 hours on the weekend. To be safe, we will count 10 hours per week and that’s 520 hours per year. So I pay her $2,000 for her 520 hours of work, which is just south of $4/hour. Not too shabby right?
So MWM will have made $11,000 in year 2016. She’s a pretty good little entrepreneur, right?
As her mommy, I’m more than happy to deduct her pay from my business,
watch her fund her Roth IRA at the tender age of 8 years old.
This one-time 5.5k she contributes to Roth IRA in 2016, assuming 8% annualized return, will double every 9 years.
She’d have (2 to the 5th power= 64x of 5.5k = $352,000) at retirement age of 62; tax free too.
If she contributes 5.5k for the next 10 years before she starts college.
The 10th 5.5k would have 4 doubling time, so still worth $171,000 at 62.
Now imagine adding up all the 10 years worth of 5.5k’s from 2016 to 2026.
I didn’t fund My Roth IRA until 30.
Mini’s certainly starting early and using time value of money as her ally, rather than a foe.
[Johanna CPA says: DWM is saving income taxes by deducting MWM’s pay from income at DWM’s higher marginal bracket and reporting in MWM’s lower tax bracket. As long as MWM has earned income, she will be able to use her standard deduction of $6,300 without reducing DWM’s Head of Household standard deduction of $9,300. Note that MWM will not be able to claim an exemption for herself since DWM will be claiming her. But that is not all: children working in a parent’s unincorporated business do not have to pay self-employment/FICA taxes if they are under age 18. That means that DWM is shaving FICA taxes from her tax bill which is a net gain. In addition, she does not have to pay federal unemployment taxes on MWM’s earnings until MWM is age 21, although she may have to pay state unemployment taxes, depending upon where they live. DWM’s strategy is also a good opportunity to teach MWM about budgeting by helping her work out a budget for MWM’s personal expenses and use her own earnings to buy extras while saving or investing what’s left after her Roth contribution and discretionary spending in a taxable account.]
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