Revenooer Rants: Do payments to kids qualify as deductions? (opinion)
The answer is … maybe. Indeed, you will find lots of commentary that such payments do qualify. But as usual, the devil is in the details — as Mr. and Mrs. Fisher recently found out as a result of Tax Court scrutiny of IRS’s view of the matter.
The Court found two issues for decision: whether the taxpayers should be entitled to a trade or business expense deduction for “wages to minor children,” and whether they were entitled to various trade or business expense deductions for amounts expended by Mrs. in connection with her activity in writing a children’s book.
These folks were attorneys — she as a sole proprietor, and he as a partner in a New York law firm. He was also the author of at least two books relating to the practice of law. They had three kids, all of whom were under nine years old as of the close of 2008.
During summer school vacation periods, Mrs. often brought her kids into her office, usually for approximately two hours a day, two or three days each week. The plan was for the kids to keep busy in the office, learning about the value of money and developing a healthy work ethic.
Their duties in the office included shredding waste, mailing things, answering telephones, photocopying documents, greeting clients, and escorting clients to the office library or other waiting areas in the office complex.
So far, so good, but the Mrs. did not issue any Forms W-2 to any of her kids, and did not maintain any payroll records related to the kids’ efforts, and did not withhold any federal income taxes.
Further, she traveled with her three kids to Disney World in Orlando, Fla., and several cities in Europe. The ostensible purpose of each trip was to conduct research for a yet-to-be written children’s travel book.
She planned to hire a literary agent by the end of 2009, but as of the close of that year, had not done so. Further, she did not submit any proposals to any publishing company during any of the tax years at issue.
Not the greatest fact pattern in support of deductions for the amounts paid to the kids and amounts spent on the book project, wouldn’t ya’ say?
As such, the Court correctly pointed out that, as stated in many previous cases before various Courts, “deductions are a matter of legislative grace, and the taxpayer bears the burden of proof to establish entitlement to any claimed deduction.”
Further, in cases where documentary evidence is substandard or lacking, the Court may estimate the amounts of such expenses and allow the deduction to that extent — the so-called “Cohan Rule” established in a 1930 case. But in any case, the Internal Revenue Code generally disallows a deduction for personal, living, or family expenses.
So in this case, concluded the Court, the taxpayers did not establish that the wages paid to the kids were actually paid or that any payment made was a payment for an “ordinary and necessary” business expense.
Slapping down the taxpayers, the Court noted that, “Keeping in mind the requirement that any deduction for compensation must be reasonable, we first note that we cannot tell from what has been presented how much was paid to each of petitioners’ children. Nor can we tell how many hours each worked or what the hourly rate of pay might have been. Without records showing these details, we cannot tell whether the amounts deducted were ‘reasonable,’ especially when the ages of the children are taken into account.”
Nonetheless, applying “Cohan,” the Court allowed a $250 deduction for wages paid to each child for each year — quite a bit less than originally claimed by the taxpayers on their return.
As for the book writing, the Court noted that as of the close of 2008, the taxpayers had not yet hired an agent, had not yet completed a final version of any book, and had not yet submitted any proposal to any publishing company, and had not yet had any products to offer for sale to the general public. Conclusion: no deductions for book-writing.
And, added the Court, don’t forget to pay the 20% negligence penalty regarding the “compensation” deducted with respect to payments to the kids.
Bottom line: Keep good records!
CONSULT YOUR TAX ADVISER – This article contains general information regarding various tax matters. You should consult your CPA regarding the implications to your own particular situation. Jeff Quinn, the author of this article, is a CPA, recently retired from Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno. He welcomes comments at email@example.com.