Tax Deductible Allowances

Paying Your Child a Tax-Deductible Allowance

Paying your children to work in your business is a good way of providing tax-deductible allowances. A child with no other income can earn up to $3,600 tax-free (Indexed for inflation). Caution: Keep very good records of the type of work they do and the hours they put in. The mere fact that you pay wages to your won't trigger an audit. Their pay is lumped in with wages of other employees on your return. But if you are audited for some other reason, the IRS is likely to question this expense. Be prepared to show that the pay was reasonable.

Personal Deduction for Corporate Donation

There is a way for owners of closely held companies to use company funds to get a charitable deduction on their personal income tax returns. The owner gives the charity stock in his/her company. Subsequently, the company redeems the stock from the charity.

Advantage: A 100% owner would not give up any ownership interest in the company, since his interest in the company after the charity is redeemed would still be 100%.

How a bailout works: The owner makes an informal agreement with the charity to offer the stock for redemption shortly after the charity receives it. The owner gives the stock to the charity. He takes a deduction on his personal return for the fair market value of the stock. A week or so later, the company redeems the stock from the charity. If the transaction is handled properly, the stock's redemption will not be taxed as a dividend to the owner.

Caution: The agreement with the charity must be informal. The charity must not be under a binding obligation to let the company redeem the stock. It must have the legal right to retain the stock or to sell it to an outsider.

Tax rule: Normally, if a 100% shareholder in a closely held company has some of his stock redeemed, income from the redemption will be taxed as a dividend. But the IRS has agreed that a redemption will not be considered a dividend if it is handled by an informal, prearranged plan with a charity. Such a transaction must be structured properly to ensure the desired tax results. Check with your accountant or attorney.

Wedding Gift from IRS

A parent who provides over half of a child's support can claim a dependency exemption if the child is under 19 or a full me student ($2,300 indexed for inflation). The cost of a child's wedding is considered support. So even if the child lives with a spouse after marriage, the wedding may push the parent's support cost over the 50% mark and entitle the parent to the exemption. Drawback: The newlyweds cannot file a joint return for the year, nor can the child claim the personal exemption for himself.

Deductible Gambling Losses

With luck, you might win big. Trap• Winnings are taxable, and winnings of over $600 are reported to the IRS. The tax can be cut by netting the gain against gambling losses, but few people document their losings. Result A person who scores a big win may wind up paying tax on the gain without getting any benefit from his/her losses. He may wind up paying extra tax even if he lost more than he won over the entire year.

Better way- Keep tabs on your gains and losses. The IRS recommends wagering tickets, canceled checks, credit records, bank withdrawal statements, and credit receipts as proof. An accurate diary is also recommended.

Bottom line: The result of all kinds of gambling is netted at year-end to determine the size of any gain. So if you are planning to be lucky at all this year, keep records for the entire year.

Commuting Cost Loophole

A home office can generate extra tax savings. Use it to convert nondeductible commuting costs into deductible travel expenses.

Key- While the cost of commuting between home and work is normally not deductible, the cost of traveling between different job sites is a deductible travel expense. And a home office can have the effect of convertingyour home into ajob site.

That's what the tax court ruled in the case of an insurance salesman who deducted all his auto-travel expenses. The IRS allowed the salesman's deduction for trips from one client to another, but disallowed his deduction for daily travel from home to his sales area. The home office saved the day. The tax court found that the salesman's home was a place of business, so all his travel costs were deductible.

Parents Supported by More Than One Child: Who Takes

When brothers and sisters support a parent, plan things so that one of them can deduct the parent's medical expenses:

Here's how:

First step: File a multiple-support declaration (Form 2120). Where several people contribute, this form designates the one who can take the exemption. If they pay at least 10% each, but nobody gives as much as half, any one of them may take the exemption if the others agree

Second step: The one claiming the exemption should pay doctor bills directly and make clear (on the check) that his contribution is earmarked for medical expenses. Then he can deduct the parent's medical expenses on his tax return. Remember Medical expenses can be deducted only for yourself, your spouse, and your dependents. You can't take a deduction for medical expenses paid for somebody else unless you can properly claim the person as a dependent.