Can Your Parents Help Your Kids and Save Tax Dollars at the Same Time?

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A few weeks ago Megan blogged about the tax-free gifting rules and how to make sure you don’t accidentally trigger tax complications, for yourself or for the person you’re giving money to. That got me to thinking about a quick tax strategy you can put into place between your parents and your kids.

To make this strategy work, you need to find a place in your business for one or more parents. The rules for employing parents are pretty simple:

  1. Have a written job description that is within the abilities of your employee
  2. Keep a log of hours worked
  3. Pay a reasonable wage for the work being done.

By reasonable, I don’t mean you have to be cheap. What would you pay someone off the street to do that same work? What are other businesses offering? What is the high end of the pay scale for this kind of work? There’s nothing wrong or unethical about paying a high salary to family members, as long as it’s not so obviously out of the box that it will raise red flags over at the IRS.

If you pay your parents a top salary for their work, they can then turn around and pay your kids’ college tuition fees as a gift. The great thing about this strategy is that as long as the tuition is paid directly to the school it’s not taxable, regardless of the amount paid. It also doesn’t count against the annual gift-tax exclusion amount ($12,000 per giftee for 2008) that must be reported to the IRS, nor are there any GST (generation-skipping tax) consequences. The amount paid must be for tuition only, though. Room, board and books aren’t covered under this strategy.

This can be a great way to help support both your parents and your kids. By employing your parents in your business, the business gets a tax break and you are able to get pre-tax income to your parents (instead of after-tax money). Assuming your parents are in a lower tax bracket than you are, that could result in a net tax saving. If your income is too high for your kids to qualify for financial aid, it can be a way of getting tax-advantaged money to them to pay for college costs.

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