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Tax Tips - Save on Taxes

Shifting Income

Following below several strategies and suggestions to help clients shift income to other family members (primarily children) who are in a lower income tax bracket.


Please refer to the next page, Gifts and Gift Taxes

Building a Child's Roth IRA

This strategy will help children build a savings nest egg in a tax-free Roth IRA.

If you have children, grandchildren, nieces or nephews of any age, consider helping each child to find employment whereby they will earn at least $6,400 in wages annually. This can be from any legitimate form of employment: babysitting, caring for pets, cutting lawns, lifeguarding, modeling, working at day camps, working at the local supermarket, etc. The child could be compensated as an employee (Form W-2), as a contractor (Form 1099-MISC), or in cash. The income received must be from wages earned; income from interest, dividends and capital gains, and gifts do not qualify for use in this strategy.

Yes, each child will have to file a Federal income tax return each year. However, they will not be subject to any Federal or state income taxes at this level of income. If they are compensated as a contractor or in cash, they will be subject to the self-employment tax of 15.3% (i.e., Social Security tax of 6.2% plus Medicare tax of 1.45%, times two) on their wages earned. On $6,400 of wages, the self-employment tax will amount to $904. This $904 represents the maximum out-of-pocket cost, per child, that would be incurred by pursuing this strategy.

Parents will still be able to claim the child as their dependent on their tax returns.

For each year that the child works and has earned income, make a contribution of (up to) $5,500 into a Roth IRA on their behalf. Over a ten-year period, such contributions would grow into a sum of $55,000 plus any interest, dividends and capital gains earned in the Roth IRA over that period. The (now young adult) child would be able to withdraw the $55,000 principal tax-free from their Roth IRA to use for the following purposes:

  1. Graduate school tuition
  2. Down payment on the purchase of their first condominium or home

The interest, dividends and capital gains income earned in this Roth IRA must remain in the account, where they will continue to grow and compound tax-free until the child reaches retirement age.

Lastly, having a Roth IRA will not hurt the child’s chances to receive college financial aid when the time comes for them to apply to college in the future.

This is one of the best tax-advantaged savings plans available.

I would be happy to discuss this strategy of shifting income to children and setting up Roth IRAs on their behalf with you at your convenience.



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