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Kids, summer … and taxes
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June 9, 2000: 10:08 a.m. ET
Know the tax consequences of keeping kids busy and safe when school's out
By Staff Writer Mark Gongloff
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NEW YORK (CNNfn) - When the last school bell rings and summer begins, parents face the challenge of keeping kids occupied and safe from bodily harm -- daunting tasks even for five minutes -- for nearly three months.
Babysitters, camps and household chores are some of the battle-tested weapons for this fight, but you should know the tax consequences -- and benefits -- of wielding them.
Putting them to work
Many parents use summer vacation as a chance to put their kids to work around the house. Most of the benefits of doing this are obvious,  but the National Association of Tax Practitioners (NATP) has gone one better and suggested that parents can actually use chores to build up IRAs for their children.
In a May 25 statement, the NATP said that, if you issue a W-2 to your child for what he or she earns doing chores, the Internal Revenue Service will consider that earned income and allow you to build an IRA or Roth IRA for her. It's a novel idea that sounds great at first, but there are potential pitfalls.
"The IRS could question the issuance of the W-2," IRS spokesman Don Roberts said. "Did this child in fact have earnings, or is this just some kind of paperwork for a parent to put money in an IRA?" If the IRS doesn't think your child's W-2 is legitimate, it could treat your payment to the child as an excess IRA contribution and tax it accordingly.
One way to avoid that is to pay your child as you would a stranger. "You have to treat them like a regular employee and pay them by the job or by the hour," Roberts said. The pay rate also must be reasonable for the work done.
Deanna Kuhn, a professor of psychology and education at the Teacher's College at Columbia University, dislikes the impersonality of this scheme.
"Speaking as both a parent and a psychologist, it has some obvious drawbacks," Kuhn Said. "Treating a child as an employee -- which is not what the relationship really is -- could be confusing to the child."
Kuhn suggested that a holistic philosophy about chores, while not allowing you to build your child's retirement, would do more for the child's well-being. "What I do with my own kids is have some understanding of privileges and responsibilities, which includes meeting financial needs with an allowance, with chores treated as contributions to family functioning," she said.
David Block, an IRS-licensed tax preparer with Tax Masters Financial Services in New York, pointed out another alarming problem with the chores-for-pay plan: Since you're paying the child from your own income -- which is already taxed -- and your child's income will be taxed, you're essentially taxing the same money twice. And, while you can deduct money you pay your child for working at a business you own, you can't deduct money you pay just for doing chores.
"This plan makes sense if you have a business," Block said. "It doesn't make sense if you don't have a business."
If you do have a business and put the kids to work there and open IRAs for them, Block recommended that parents open Roth IRAs, rather than ordinary IRAs. While contributions to Roth IRAs aren't deductible, withdrawals after the age of 59-1/2 are totally tax-free -- and your kids can withdraw money early, without penalty, if they use the money to buy a first home, for college expenses, or if they're disabled.
Avoiding the 'Zoe Problem'
If you hire a babysitter to work in your home this summer, then you're a "household employer," according to the IRS. If you pay that sitter more than $1,200 a year, then you must jump through a series of hoops to comply with the law and avoid the dread "Zoe Problem." It's named for Zoe Baird, whose candidacy for U.S. Attorney General was scuttled when she admitted that  she'd hadn't paid payroll taxes for nannies who watched her kids and cleaned her house.
IRS Publication 926, the "Household Employer's Tax Guide" tells how to avoid the Zoe Problem. In a nutshell, you must:
- Get an employer ID number.
- Verify that your sitter is not an illegal alien.
- File a form W-2 for the sitter.
- Withhold and pay Social Security and Medicare taxes.
- Pay unemployment taxes.
- File a Schedule H with your 2000 tax return.
- Pay state unemployment taxes, if any.
You might also have to make advance payments of the babysitter's earned income credit, if he or she is eligible for that. If you and the sitter agree, you might also end up withholding state and federal taxes.
Sounds fun, huh? "It's a hassle," Block said. "Most people want to avoid it, but it's against the law if you have the person working in your house" and don't let the government know about it.
Block had a simple solution for those of us who don't want the headache: get child care outside the home. "If you take the kids next door, you don't have to do all this," he said.
The child-care deduction: oasis or mirage?
One reward for all that hard work -- aside from avoiding embarrassment at your confirmation hearing -- is that you will have proof of a child-care expense, some of which could be deductible.
IRS Publication 503, "Child and Dependent Care Expenses," will help you figure out if you're eligible to deduct child-care expenses and how much you can deduct. Some important things to keep in mind:
- In order to be deductible, the child-care must be work-related -- no deduction for sitters you hire when you jet to Jamaica.
- The most you can deduct is $2,400 per child, for up to only two children.
- In order to qualify for a deduction, you have to get the babysitter's Social Security number, which is sometimes easier said than done. "Most people that provide child care in New York don't want to give their Social Security number to parents," Block said. "There's an underground cash business for child care, and the IRS is cracking down on it."
Overnight camps are not deductible expenses, but day camps could be, if you can convince the IRS that they're work-related.
Little League, swimming lessons and other such diversions might also be deductible as child-care expenses, but Block said you could have trouble getting the IRS to allow them. "Those are in a gray area," he said. "It's hard to say conclusively that they're child care." In addition to proving that they're work-related, Block suggested that you get documentation of such expenses -- including the provider's tax ID number -- before you try to float them by the IRS. 
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