Richard A. Lindsey, CPA

Lindsey & Waldo, LLC – Certified Public Accountants

  • May 12

    I’ve written before about what a good tax planning technique hiring your children can be. (See “Hiring Your Children for the Summer: The Job of Last Resort or Just Good Tax Planning,” Taxing Times, June 2015.) It can be an effective way of shifting income from your high rate to as low as zero percent! It can also be good for the kids. However, as a recent tax court decision demonstrates, it’s important to dot your i’s and cross your t’s.

    The case involved Lisa Fisher, a New York attorney, faced with a common dilemma to find summer care for her children, all under the age of nine. So, during the summer, she brought them into her office two or three days a week where they shredded waste, mailed letters, answered phones, greeted clients, and copied documents.

    Fisher took deductions for the $28,770 in wages she paid her kids over a three year period. But, she didn’t keep any payroll files or issue any W-2s. She didn’t keep any records substantiating the work they did or establishing that she paid “reasonable compensation” for the work performed. Nor could she present any documentary evidence, such as cancelled checks or bank statements, to verify that she actually paid them the wages she deducted.

    You know where this is headed. The IRS disallowed the deductions for the children’s wages and imposed an accuracy related penalty. The Tax Court affirmed that decision.

    Bottom line: Hiring your children to work for your business, or rental properties, can be perfectly legal tax planning. But, you have to follow the rules and document everything in order to protect the benefits.

  • May 2

    Today’s sandwich generation is squeezed between the obligation to care for their aging parents and their grown children.

    It’s hard enough to pay your bills and save for retirement, but it’s even tougher when you have to juggle responsibilities, providing for your own financial needs while lending a helping hand to your elderly parents or grown children — or both.

    A recent study estimated that one in eight Americans between the ages of 40 and 60 are simultaneously providing some financial assistance to both a child and a parent. Other studies have shown that more than 50% of Americans expect to provide assistance to both. The obligations of taking care of aging parents demand considerable time and money, sometimes as much as your children. But, are they your dependents?

    From a tax standpoint, a dependency exemption deduction is available for each person who is a dependent of the taxpayer for the year. A dependent is defined as either a qualifying child or a qualifying relative.

    To be a qualifying child of a taxpayer, an individual must satisfy five tests:

    1. Relationship. A qualifying child must be the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual.
    2. Residency. Have the same principal residence as the taxpayer for more than half the tax year.
    3. Age. Be under age 19 at the end of the tax year, a student under age 24 at the end of the tax year, or permanently and totally disabled at any time during the tax year,
    4. Support. Did not provide more than half of such individual’s own support for the tax year.
    5. Married child. The individual, if married, cannot file a joint return with his or her spouse except as a claim for refund.

    Individuals who do not meet the test for being a qualifying child of the taxpayer may still qualify as a dependent of the taxpayer as a qualifying relative. A qualifying relative is an individual who passes the following three tests:

    1. Is a specified relative of the taxpayer, or if unrelated, has as his or her principal residence the taxpayer’s home and is a member of the taxpayer’s household. Under this rule, a dependency exemption may be allowed for a domestic partner and a domestic partner’s children, provided all the other tests for a qualifying relative are met.
    2. His or her gross income for the year is less than the exemption amount. This test disregards tax-exempt income such as certain scholarships and the nontaxable portion of social security payments.
    3. The taxpayer provides more than one half of the individual’s support for the tax year. While a supported person’s nontaxable income (e. g., nontaxable social security benefits) is not considered when computing that person’s income for the gross income test (see number 2 above) it is considered when determining the amount of support the person provides under the support test, to the extent such income is actually used for support.

     

    Therefore, a qualifying relative can be a:

     

    Child

    Brother

    Father-in-Law

    Grandchild

    Sister

    Brother-in-Law

    Uncle

    Great Grandchild

    Stepbrother

    Sister-in-Law

    Aunt

    Stepchild

    Stepsister

    Son-in-Law

    Nephew

    Parent

    Stepparent

    Daughter-in-Law

    Niece

    Grandparent

    Mother-in-Law

     

    Even if a child of the taxpayer does not meet the definition of a qualifying child, the child may still qualify as a dependent of the taxpayer as a qualifying relative.

    Example: Paul’s son, Samuel, is 22 years old and is not a full-time student or disabled. Samuel’s gross income is $2,500 and Paul provides 75% of his support; Samuel’s grandmother also contributes to his support. Samuel is not a qualifying child of Paul or his grandmother because he fails the age test. However, Samuel is Paul’s dependent because he meets the definition of a qualifying relative (i.e., he meets the relationship test because he is Paul’s son, he meets the gross income test because his income is under the exemption amount, and he meets the support test because Paul provides more than half of his support).

    If the dependent is related to the taxpayer, it does not matter where he or she resides for the year, as long as the gross income and support test are both met.

    Example: Cindy is 20 years old and not a full-time student or disabled. She lives with her friend for the entire year, and her grandmother Gigi provides more than 50% of her support (she has no gross income). Gigi can claim Cindy as her dependent because Cindy is a qualifying relative. Cindy does not have to live with Gigi during the year.

    In determining the amount of support provided to an individual, the value of lodging is included in the support test.

    Example: David and Michelle Butler help support Michelle’s widowed mother, Mona, who is 72 years old. Mona lives rent-free in one side of a duplex the Butlers own. The fair rental value of the dwelling is $8,400 a year. Mona provides her own furniture, but the Butlers paid utilities, which were $1,200 in the current year. Mona’s income consists of $8,000 of social security benefits and $300 of interest income, all of which she spends for her own support. The annual fair rental value of Mona’s household furnishings is $1,200.

    The Butlers provide more than half of Mona’s support for the current year. Their support is $9,600 ($8,400 value of dwelling plus $1,200 utilities), while the support Mona provides for herself is $9,500 (income of $8,300 plus $1,200 value or furnishings). Mona also meets the other test for dependency as a qualifying relative (i.e., relationship and gross income). Thus, the Butlers can claim Mona as a dependent on their form 1040 and take an exemption deduction for her.

    Note: Mona’s social security benefits are included in determining the amount of support she provides for herself, but are excluded for the gross income test since they are not taxable income to her.