Welcome to Radical Personal Finance, the show dedicated to providing you with the knowledge, skills, insight and encouragement you need to live a rich and meaningful life now while building a plan for financial freedom in 10 years or less.
One of the core aspects of good financial planning is to lower expenses. And for most of us, taxes comprise perhaps the largest percentage of our budget. Of course, there are many forms of taxes, but when taken in aggregate, add up to a tremendous amount of money. Today I’ve invited Craig Cody, who’s a tax planner, on the show. Craig, welcome to Radical Personal Finance.
So I’m excited to have you on and to talk with you. I love to talk with Accountants and Tax Planners about specific ideas and strategies for how my Listeners can reduce their taxes. Now, obviously this is a difficult subject to capture in something like an interview, given that there are so many types of taxes. And there’s so many plans and so many strategies depending on a specific situation, but what I want to focus on is running through some ideas and some strategies of how my Listeners can begin to approach the subject. But in order to engage their interest, you’ve contributed to a book called “Secrets of a Tax Free Life. Surprising Write-Off Strategies Most Business Owners Miss”, which is quite the title. And your chapter contribution is called this, “How to Deduct Your Kid’s Soccer Cleats. Hint: Give Them a Seat at the Boardroom Table”. Here’s what I want to know. How do I deduct my kid’s soccer cleats?
Let’s just say you’re a self-employed individual. You’re a real estate agent and you want to prospect for homes in your area that are actually maybe new listings. So you hire your kid to go out there every Saturday morning for about three hours on his bicycle and come back to you with a list of addresses of homes that are for sale that you could do some further research on. And you decide, “Okay, I’m going to pay you a $125 a day.” And it has to be reasonable compensation. All right? And then your business now deducts that money and pays your child. OK, let’s just say your child is going to private school or your child is on a hockey team and it’s expensive. He’s on a travel team. So you pay your child. You get a tax deduction for the payments to your child. Your child who’s probably going to make less than $4,000 a year is then going to have no taxable income at the end of the year. And he’s going to use that money to pay for — whether it’s a private school, his cleats, his hockey lessons his piano lessons. So basically you’re taking something that’s a non-deductible expense and you’re making it a deductible expense. Of course, you’re paying somebody to perform a service for your business.
Are there any limitations on the types of things that I could hire my kids to do for me?
It has to be reasonable. So if your child is not a brain surgeon, you can’t pay them $1million per year to go around and check on properties. So it has to be reasonable compensation and you could do that kind of research online to see what reasonable compensation is. And typically with a child, we like it to be less than $6,000 a year because of the reporting requirements, et cetera. But $6,000 a year to somebody that’s in, let’s just say the 25% tax bracket is $1,500. If you have three kids, that’s $4,500 a year in savings.
Explain more of what you mean as far as what the difference is? Why $4,000 a year? Why $6,000 a year? Why are you looking at these numbers?
Because at a certain point, your child has to file a tax return and you don’t want the tax that he winds up paying to be equal to the tax that you have to pay. And basically, we want to make it so your child has to pay no tax. So that’s why we use that $4,000-$6,000 number.
Have you hired your kids? Do you have kids?
For business? I’ve hired my kids. My kids have gone to a Catholic school and that’s how they paid for their Catholic school. They worked for me. I made sure the money went into their bank account and this school would deduct that money every month and pay the tuition. They did a job and we kept good records.
How old are your kids now?
So what type of records did you keep for your kids?
Well, every Saturday when they worked, they’d have to sign-in in the morning. And then they have to sign out at the end of the day. We kept those records, and we kept them in a file. We pay them. We have to make sure when you pay them that it went into their bank account and then, every month the school drafted the bank account to pay the tuition.
Did you do any strategies such as — I know one that parents are often thinking about — doing something like making up your own parental match of money and then contributing it into a Roth Ira. Did you do any of that capital kind of thing with your kids?
No, we didn’t do that, but that’s another thing that people will do is they’ll pay their child so the child can put money into an IRA. So by the time they’re 18, they could have substantial money in there. Another thing we do is we have a lot of real estate agents and they tend to have children and children tend to need braces. A real estate agent will set up what’s called a MERP plan, which is basically a medical expense reimbursement plan. So typically when we have our medical expenses on our personal tax return, we deduct them on Schedule A. If they don’t exceed 10% of our adjusted gross income, we really don’t get a deduction for it. So instead, our realtors will set up a Section 105 plan, which is fairly simple to set up. Then they will be able to deduct the cost of certain medical expenses, most medical expenses and get a dollar for dollar deduction.
I want to come back to that in a second. Let me just real quickly explain the Roth Ira thing for kids, for my Listeners who may not be familiar with it, in order to make contributions to any type of a retirement account, like a traditional IRA or a Roth Ira, the contributor needs to have earned income. So in this case, a child needs to have earned income. So if you’ve arranged a situation where your child can work each Saturday and earn as Craig said, $4,000 per year, perhaps that $4,000 per year counts as earned income and they can contribute all of that up to either the yearly maximum or up to the maximum of their earned income into a retirement account. So what many parents can choose to do is they will help arrange employment for their child. So they have $4,000 of earned income.
And then they’ll also make a bonus gift to their child. Have something like $4,000 and the $4,000 will go into the Roth Ira, which is the child’s earned income. And then they’ll go ahead and contribute or gift to the child, $4,000, which they can then use for living expenses. So it’s a way for the parents to give money to the child, but giving it in such a way that it can be put into a Roth IRA which can which can grow tax free forever. And one of the major benefits of that is because the child is earning a very low amount of income and they’re paying taxes on that $4,000 of income, they’re paying taxes at either a zero or a 10 percent rate depending on the bracket, and it’s a very, very low effective tax rate. So it’s a very useful way for essentially a parent to help a child fund a Roth Ira from an early year. And if you start that, where you can help them get employment at a very early age, you get a tremendous growth of compounding over time. Is that about accurate? Greg? Did I miss anything important?
You did not miss anything.
What’s the earliest age that you’ve seen a client be able to justify hiring their children?
I believe the tax court says we typically would not use anyone less than 11 years old and it really depends on what they’re doing, but I’m more comfortable with somebody 11 years old and older.
So back to the Section 105 plans. How would I, if I have a business radical personal finance and I could hire my kids in that. How would I go about setting up such a thing if I know my kids are coming up with braces and I want to set up such a plan? How, mechanically, do I research that and do it.
It’s a relatively easy setup. It’s a simple couple of page document. What you basically do is you hire, let’s just say your spouse, And the Section 105 plan says that for her reasonable compensation, I’m able to pay her certain medical expenses, up to whatever would be reasonable compensation for the job she’s performing. and then those medical expenses for her family. So that would cover her children and her spouse. So she’s not actually getting a W2, compensation is in the form of a Section 105 plan.
All of her compensation under that Section 105 plan.
Well, I mean it has to be reasonable compensation. So if it is reasonable compensation, yes, all the compensation could be under Section 105 plans.
The benefit of that is a couple of things. For example, if my wife and I are both working in the same business, then if we go on something like business travel for both employees at the same company, we may be able to deduct the forecasts of those expenses instead of simply deducting the cost of my expenses. And that would be much easier to do if we were both employees of the company. It’s much easier to dock the other personal expenses whether that’s cell phone costs and similar things. Am I accurate in those statements?
Correct. That’s my understanding of this subject. If you want to answer any tax question, I have a lot of beefs with the IRS. I have a lot of beef with the tax code, but when I study it, generally I find that there’s a pretty consistent theme throughout it that if this is a business expense and it’s a legitimate business, expenses are deductible and you can indicate if it is or if it’s not. And that’s a doctrine that continues through in every area. I’d love to hear some other stories. I mean, you’ve been doing tax planning for 16 years,
16 years. We’ve been focusing on it for a business owner for about six or seven years. There’s another thing we called the Augusta rule. Augusta, Georgia is where they have the US Open PGA tour every year. I guess there’s not a lot of hotels for people to stay at. So the government basically wanted people to rent out their homes. So basically if you rent your home to your business for less than 14 days a year, 14 or less per year, your business gets a deduction and the homeowner does not have to pick up the income on a tax return. So basically if you have events at your home for your staff, you could rent your home to your business, Your business pays you personally, and your business gets a deduction, and you don’t pick up the income.
You’re thinking of things like a company party? Or like a planning meeting or a board or corporate meetings, something like that?
Any type of a board meeting, staff meeting, it has to be. You don’t have to see what they would charge if you went to a restaurant and said, you know what, I’d like to rent your room, but I’m not going to buy food from you. How much are you going to charge me? So once again, you have to make sure that your numbers are correct.