A CPA (not my CPA, I currently do my own taxes) suggested a few ways to reduce taxable income by paying family members or friends to do work for you (e.g. clean, paint, wash your car) and issue 1099 or W-2. I currently own rental properties and my two adult kids rent from me. They did do work for me -power wash a fence, clean out garage etc (not a daily or regular basis so I wouldn’t classify them as employees for me who would need a W2).
My taxable income has gone up (I’m a full time W2 employee so I can’t claim Real Estate Professional
Status). If I pay one kid say $5000 for the year (far below the $14k threshold), write off the expense and issue a 1099 so they report it as income will that be a red flag for the IRS, if I’ve never paid a family member before? I have issued 1099s to contractors who’ve done work on my properties. And they’re renting the property they’re doing work on? Thoughts about this strategy in general?
Paying family members and issuing 1099s, a red flag?
byu/Small_Exercise958 intax
Posted by Small_Exercise958
11 Comments
Your children will claim and pay taxes on the money, right?
Was all the work on your rental property?
Are they paying fair market rental rates?
Family businesses are older than taxes.
Your kid will need to file a Schedule C and pay self-employment tax on that income, but otherwise, no, this is not a red flag to the IRS. They legitimately did work for you and you paid them for that work; that’s fine.
Note that your kid can use that earned income (minus 1/2 their SE tax) to contribute to an IRA (may as well do Roth since they won’t owe income tax on it regardless). It would be very good of you to do that for them, even.
This CPA is the reason why we need more IRS agents to do audits
>(e.g. clean, paint, wash your car)
Just to be clear here, issuing a 1099 does not make personal expenses such as washing your car deductible.
>far below the $14k threshold
This would be self-employment income, and that reporting threshold is $400 of net income.
>suggested a few ways to reduce taxable income by paying family members or friends to do work for you (e.g. clean, paint, wash your car) and issue 1099 or W-2.
Thoughts on that “strategy” in general are – its not a strategy, its simply “compliance” with reporting requirements.
***Example 1***: your F&F (friends and family) are already providing work/services to your business activities
Yes, you should pay them.
Yes, it should be reported correctly (W2 or 1099 as applicable).
Yes, you should start doing this correctly even if you did it wrong in the past
***Example 2***: your F&F are not currently working for you, but you want to start paying them for ‘work’ solely to save on your tax bill.
That is insane. Your tax savings are going to be far less than the $ you pay to the F&F. So you are just giving your money away.
If the F&F are looking for work and you want to hire them to get things done – that’s fine. Otherwise, it is a waste of $ on your part.
Additional feedback on your specific situation (paying kids who are also tenants)
To your example, OP, you are starting from an “out of compliance” position. Kids are actually working, and you are not paying them and/or not reporting the payments.
So yes, you should correct the mistake. But it is going to cost you and/or them in payroll taxes (social security and medicare) depending on the W2/1099.
The income tax savings might be more than the payroll cost – but maybe not, it all depends on the particulars.
But it is not a “red flag” to do things *correctly.* Which is what you are asking. “I’ve done this wrong, should I start doing it correctly?” – that answer is “YES”.
And you can’t double dip. I.e. you can’t collect 5k less in rent (because they are performing work) and ALSO deduct 5k for the work they performed. That would be double dipping, because you are reducing gross rents AND claiming a labor deduction on the same dollars.
There are so many pitfalls. If an independent contractor situation is set up (1099) then you have to have little or no control on the means of accomplishing the task, or else you may have an employee (w2 situation). The IRS is extremely aggressive on this because the penalties are huge. A w2 situation means payroll taxes and also might mean workers comp insurance.
For a 1099 make sure you’re paying only for the results. They generally have to use their own supplies. Paying an individual is a huge red flag, especially a child.
DBAs are cheap to set up and they offer your workers an easy way to deduct expenses against the 1099 on their Schedule C. The DBA has a bank account that you pay to. They must prepare an invoice. (Or write it for them😎) It’s not foolproof, but it’s a pretty good shield. I am not sure I want to see a child with a schedule C, but they’re almost always an employee because of likely control over the means (exception next paragraph.). In most states, children employees of parents are exempt from child labor laws. There are lots of child employees out there—I was once one 60 years ago sweeping up for my dad’s hardware store. The beauty of a child employee is their earned income isn’t subject to the kiddie tax and that child can set up a Roth IRA. My children used it toward a down payment on their homes. I wasn’t totally happy about it, but it’s their money and they asked.
Paying relatives for work is quite common. I’ve found that the going rate for having family members model for an ad brochure is $5000 per person, and a 1099 is issued. Dentists and lawyers do that commonly. They’re paying for not only their time, but lack of privacy with their mug plastered everywhere.
Bottom line, it’s a red flag. Just line up your defenses and see if it “smells”right.
Sigh.
Just pay your share. Don’t do this to your kids. Also, consider a better CPA for the future. This one may not be as good as you think he is.
Pay your taxes and move on please and also don’t come to social media for answers. You clearly make a good amount of money and have investment properties, hire a CPA professional for your investment questions
If you issue them at 1099 then they have to pay taxes. Even below the threshold they are required to pay fica 5.3 pct
Sorry 15.3