Hiring kids for a rental LLC

[Jane Z.]

Hi,

I have several children related tax question. After consulting with my CPA, I am now confused. Here is my situation.

My husband and I set up a rental LLC several years ago. The same CPA told us since only my husband and I owned the LLC, we should file Schedule E on our tax return. So that is what we have been doing. Lately we are considering hiring my two kids, who are under 18 years old, for some office work, such as setting up a rental website, mowing lawn, bookkeeping, etc. The CPA told us since we file our rental income using Schedule E, our rental properties will be considered as an investment. Unless our rental LLC is considered as a business, my kid income will subject to social security tax and Medicare tax, although not income tax if it is under $6300. Since we manage our rental properties ourselves, I told him our rental LLC should be considered as a business. In that case, the CPA said, we should file Schedule C instead of Schedule E and pay self-employment tax. Then I ask the CPA could I pay my kids to set up a rental website just like we pay a plumber to fix a toilet? My CPA then said yes, in his words, ‘There is no difference on your side to pay them vs to pay a plumber. There is no difference on their side to earn from working for you vs working for others.' Here is my confusion. If we pay my kids to set up a website and deduct those expense as rental expense, what kind of tax my kids need to pay? Do they need to file a separate tax return? Or what is the best tax strategy in this scenario? I feel I have asked my CPA too many questions and want to see how other people handle this.

Thanks a lot for help.

Jane

[Karolis Matulis]

How much are you looking to pay them over the course of a tax year? The pitfalls of these kind of scenarios is generally proving to the IRS that the payment was for actual work done. The easiest way to make this work is to treat the kids as contractors. Have them perform specific tasks and issue invoices that the LLC would pay. This would leave a paper trail and a record of work actually done. Everything needs to be reasonable and payment/cost needs to be similar to what you would see in an arms-length transaction with an unrelated party.

At the end of the year you'll need to issue 1099-MISC to both kids for the total payments through the year. They will have to file individual 1040 returns and report that income. The income will be subject to the self-employment tax (medicare and social security) as well as income tax (they can claim expenses if there were any in them performing their services).