Taxpayer asks:
Hi,
My husband and I have decided to open a bank account for our son. We’re going to give him an allowance every week. He gets to keep part of it and put the rest in the bank. If he saves a certain amount, he gets a bonus allowance. The point is to teach him to save.
My question for you is how do we report the money we’re giving him? And does he need to file taxes for the bank account? He is 8 years old and his allowance is $5 per week.
Taxgirl says:
What a great idea! I may have to try that one myself…
There are no income tax consequences to your son for an allowance; similarly, there are no income tax consequences to you for giving an allowance.
Technically, there could be gift tax consequences since an allowance is really a gift – but doing the math here, I’m guessing it’s rare that, together with your other gifts to your son, you hit gift tax type numbers ($13,000 per person per year for 2009).
As to the bank account, interest reported to your son might be subject to income tax. However, the amounts that you’re talking about are small enough that they likely won’t be… Assuming that you claim your son as a dependent and he has no earned income, he can earn up to $950 in unearned income (like interest and dividends) income tax free for 2009 for federal purposes. That amount is the equivalent of the personal exemption. There’s no need to report that income or file a return.
The next $950 would be taxable at your son’s own tax rate. After that, using the “kiddie tax” rules, he would be taxed at your (meaning his parents’) marginal tax rate. It sounds like neither of these situations would apply to you but I wanted you to be aware of them.
There are additional rules and exceptions which apply to the “kiddie tax” rules – I’m not going to discuss them here other than to say that the rules are much different if your child has earned income or significant unearned income. If that’s the case, you’ll want to consult with your tax professional.
It’s also worth pointing out that these are the federal rules – your state may have different rules. Again, consult with your tax professional.
(Note: The “kiddie tax” rules have changed in 2020.)
Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.
I love this blog! Just heard about you through some mutual lawyer friends (know you’ve been a star for awhile, we’re new bloggers). But if I hadn’t gone the legal writing route, I could have been Taxgirl. Love the way you tell it simply — this is great! -Hollee
Kelly, why do I believe there are times you really wish I didn’t read your blog, which I do think is sensational?
However, I think an answer was overlooked here. Instead of “giving an allowance” to the child. Especially when the child is a little older, the child should “earn” what he/she is gets.
If the child is paid for example for mowing the grass. If the child is paid for example for cleaning the room. Then the child “earned the money” has to be reasonable for the age/experience work performed. But then instead of just giving the money to the child. A Roth IRA can be opened at their savings institution and those monies earn interest free and used for the expenses @ time of school of college etc.
If the parents live in many states such as Indiana, they could consider instead of a Roth IRA putting those monies into a 529 college plan. In our State the contributions in a 529 plan gets a 20% refundable credit on the state tax return.
But the mom seems to be intelligent in wanting to plan ahead and do the right things both on the tax return and for the child’s future.
Jeff
Getting off the subject here, but Jeff started it.
An allowance is a great way to teach kids financial responsibility. However, you get into trouble when you try to tie it to chores. As a parent, you are giving them money so they can learn to make choices with that money. You buy them everything anyway, so you’re not really loosing anything that way. They get money because they are your kids. You love them and want to teach them about money. They do chores because they are part of the family. Period. Especially when the child is older and perhaps no longer “feels” like mowing the lawn that week. Do you then withold their allowance and prevent them from learning about money? No.
Also, children should NOT be opening Roth IRAs or 529 plans. That is for the parents to do. Children should open savings accounts that they can use in the near future for something they want. -A new toy or computer game. This is a great way to teach children good saving and spending habits.
¢¢ – Nate
I do not give financial advice in of itself, I suggest they go to the local credit union they bank or wherever. However, @ the same time, I feel it is my obligation to advise the most advantageous situations they can take and the client determines what they want to do.
I may have not made myself clear, tho in that I would never suggest the 529 be in the child’s name. However, for example I have a client that has three children in range of ages about 11-15 yrs old this last year. Through the years each of the children savings accounts had between $1000 and $2000 in a savings account. I told them if they visited the credit union and put those monies in a 529 plan they would gain 20% on the money. So all of a sudden those children’s monies grew $1000 between them. I am confident that those particular taxpayers will then find a way to put more in again in the future years.
But more than just giving an allowance for chores around the house, I hate when I find someone has their own business (schedule c) and the grandfather just gives his grandson some money and doesn’t know that he can pay the grandson and put the money in a Roth IRA. Deduct the expenses off his schedule C (it is month to month storage units) for the mowing of the grass and emptying the units when folks leave all their garbage instead of just giving the child the money. And he is @ at 25% tax rate and the amount goes in a ROTH IRA @ zero taxable income to never be taxed, in that particular case the children’s aunt is a manager of the local bank. 5 years after the 1st year, that grandson that is now 16 yrs old has aproximately $10,000 in that ROTH IRA.
It is the parents to decide if they want to “pay’ for the chores not mine! But I have an obligation that if they want to utilize the laws it is there for the choosing. If the dad wants to pay $300 for the chores and puts in a ROTH IRA for the child and then is suave in the art of the stocks, who knows. If he wants to let his child use the money for toys, that is his decision not mine. But he sits at my desk he knows all the options.
Which I thought the original mother should be given since she wanted advice.
Which is why I don’t like the freebies preparers etc. I think no approach fits everyone and everyone should know all the options that are available to them. Do I think it can be risky in crossing the line out of legalities, which is now redundant, that’s why I don’t like inexperienced making the decisions or giving the advice.
Why shouldn’t the IRS and the Federal Reserve get a cut off the kid’s hard-earned lawn-mowing money? They deserve it, don’t they???