The IRS tends to view employment arrangements between parents and children with a touch of skepticism. So be careful to observe the strict letter of the law when you hire your child for the summer. Here are a few points to keep in mind.
- Treat your child like any other employee. Make sure the child completes a W-4, fills out time sheets when appropriate and follows other company procedures. Don't give your child special leeway to run personal errands while he or she is on the clock.
- Pay your child the going rate for the job. Providing an exorbitant salary for an entry-level position or setting a flat rate at the beginning of the summer is likely to draw the ire of the IRS. Establish an hourly rate that is reasonable for the work performed.
- Follow the payroll tax rules. Impose the usual withholding amounts to your child's wages unless he or she qualifies for exemptions. Issue an annual Form W-2. Don't make any exceptions for your child.
Of course, taxes will be withheld from your child's wages, even if he or she won't have any income tax liability for 2012. But in this case, you can have your child avoid income tax withholding by entering the word "EXEMPT" on Line 7 of Form W-4.
This is only available to a child claimed as your dependent if he or she had no tax liability for 2011 and won't earn more than $5,950 in 2012. If your child exceeds the limit, a new W-4 should be filed.
