19 Sep 2022 Tax Savings & Gifting for Children or Grandchildren
Authored by Haynie & Company Partner Bernard Abercrombie, CPA.
There are several gifting or tax opportunities for children or grandchildren, this article highlights a few for teenagers and young adults.
Savings for Business Owners
The most beneficial concept occurs when a parent operates a business as a sole proprietorship (or disregarded single member LLC) and employs one or more of their children that are under the age of 18. The child must perform legitimate services at a reasonable rate of pay for the services provided. Due to the close nature of the relationship and potential IRS scrutiny, excellent documentation should be maintained. When paying a child from your sole proprietorship, the business can deduct those wages just as if they were paying any other employee. The benefit is that the child can earn nearly $13,000 and pay no income tax on it. The exceptional extra benefit is that neither the parent nor child must pay any Social Security or Medicare. So, in the end, the parent receives the tax deduction, and the child pays no taxes, thus shifting income from the parent’s bracket to a zero-tax bracket. It should be noted that this does become the child’s income and would need to be deposited into a UTMA type account for the child.
Roth IRAs for Working Children
Another opportunity for a working child is that a parent or grandparent could contribute to a Roth on the child’s behalf. The amount that could be contributed is the lesser of the income they earn for the year or the maximum Roth contribution limit. The limit in 2022 is $6,000. As you are probably aware, under current law Roth accounts grow tax free, so amounts contributed or earned inside a Roth are free of any tax when withdrawn. Since this amount is well below the $16,000 annual gift exclusion, no gift taxes or filing are required.
Save on College Expenses
Another opportunity exists to pay for certain college expenses out of an IRA account. Funds can be withdrawn from an IRA account early without penalty when certain conditions are met. Funds used to pay for tuition, room and board, books, and certain supplies and equipment are considered qualified educational expenses.
Also, tuition paid directly to a college or university can be made without impacting the annual $16,000 exclusion. As an example, if a parent or grandparent were to pay $25,000 in tuition directly to a college or university, they could also give up to an additional $16,000 and still not be required to file any gift tax returns.
Finally, if a parent or grandparent funds a 529 plan for a future student, a single gift of five years of annual exclusions may be made in one year without utilizing any of the lifetime exclusion. There are some strings attached, however. First, the single contribution is considered a contribution of $16,000 per year for five years, so no further gifts may be made without utilizing some of the lifetime exclusion during the five-year period. Second, if the donor dies during the five-year period, unused years are clawed back into the estate for estate tax purposes. Finally, a gift tax return must be filed to report the gift and the election to spread the gift over five years.
Gifting rules can be complex. Consult your tax advisor for more information. At Haynie & Company are happy to assist you with all your tax planning needs.
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