I have a patient who said his 10 year old son has a Roth IRA. The son earns money from mowing lawns, yardwork, etc.

All of this earned income is invested in the IRA and the dad just 'matches' or replaces the money so the kid can have pocket money.

Is this legal? A 50 year investing horizon is fantastic but isn't this a red flag for the IRS folks? Any real opinions are appreciated.

If the neighbors pay the kid for mowing the grass, do they have to report that and take out taxes, social security, etc?

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Jennifer
90 350sdl

I assume the Roth requires W2 income, as does a regular IRA, not just yardwork money. What if I say I mowed $300000 worth of yards, and contributed appropriately- where's the proof? But I give no legal advice, and no tax advice. There's a taxman around here somewhere....

You have to pay income taxes on the money that goes in. If there is an audit, the IRS will want proof of that tax has been paid on it. To keep it legal the kid needs to file a tax return on his lawn money, which will probably result in zero tax owed, but will be proof that the money put in was accounted for under tax law. Whether his dad gives him money or not is pretty immaterial - unless dad is moving large sums of money in and out of the kids bank accounts, nobody really gives a rats ass about small cash transfers to kids.

Believe it or not, if they are filing tax returns, what they are doing is brilliant. Any gain on a Roth IRA is tax exempt. Lawn mower money invested as a kid will probably be worth a bundle when he retires, especially if he puts it in a nice growth stock.

Send him a check for $250, then he'll tell you.

He's probably laughing because the advice I gave her will send the kid to Leavenworth for ten years.

Yes it is legal, the child has to earn it and can put in his earnings up to $3,000 per year. On $3,000 earned income there would not be any income tax but he would have to pay self-employment taxes. This is a great plan that I use very often with my clients. And if it is a parent's business that has hired the kid the parent gets a tax deduction.

It's a smart way to go. Kirk's right, the kid has to file a return and declare the income, but if he makes less than or up to the Roth limit, there's zero income after the deduction. Even if the kid makes a fair bit more, the first $3k is written off, as is the standard deduction and exemption, so he'd have to make a lot more than that before he'd owe tax. I wish I'd had $2-3k of tax free dollars compounding a year from when I was ten, it would be a decent nest egg by now.

As for Dad's "replacement" cash, gifts of up to $11k/year are tax free to both the recipient and the giver; besides, the IRS has bigger fish to fry than going after a kid's allowance.

Don't be so sure about that. They came after me for $900 of unreported income a few years ago. Any time the computer system detects an imbalance or discrepancy, they'll send a letter stating how much you owe. This is oh-so-much easier than going after the cheats who owe millions.

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Rick Miley
2014 Tesla Model S
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There is a hugh difference between earned income which can be the $3,000 and it is income tax free but you do owe self-employment taxes unless he is on a w-2 with his natural parent as the employer, and unearned income which is taxed at a much lower level. It is a GREAT way to help make your children wealthly and give you a tax deduction, let them empty the trash etc, at your pratice or office. This is legal I've been thru several audits with my clients, but the children have to earn it. Dairel

The boy Father would be better off placing the money in a SEP/IRA account. The deposits are not tax able and there are no reports or paper work to file with the IRS. Either IRA is a good investment. At 59 the boy will have quite a nice portfolio.
Happy driving.

joe moon

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joe moon/95Benzman

Making a SEP/IRA would NOT be better than a Roth IRA because it is very likely the boy would pay no income tax on his earnings. As a result, any tax deduction from the SEP/IRA would be lost. Also, the allowed SEP/IRA contribution would probably be much less than the $3,000 Roth IRA contribution. Finally, the Roth IRA after growing for 40 to 50 years would be fully non taxable under the current tax code, while the SEP/IRA would be completely taxable at that time since it is only a tax deferred plan.

Bob you are right! I would even consider a vul after the roth if you are wanting to do more for their retirement. No gov't paperwork and if healthly and young very little ins. cost and another tax-free retirement plan, that can be started at any age, not just 59 1/2. Dairel