Make College Tuition Tax Deductible
Ok, everyone knows that college tuition is not tax deductible, but when a person gets a little creative, starts planning early, and follows the law they can fund their kids college as a tax write off.
In this HUB I would like to talk you through a scenario where you can accomplish this legally, but you must do it write and keep accurate tax records.
Utilizing Rental Property to Fund College
If you've read many of my HUBS you know that I favor buying rental property. There are many benefits to it, but the one I will describe here can be major. To write off your college tuition simply hire your children to work for you on your rentals. At this point in time you may not have a rental, but don't stop reading because this may be the reason why you want to start buying some.
By law you are allowed to pay reasonable wages to your children to work on your rental property. These deductions are reportable on your schedule E which means they are a direct write-off from your rental income. The idea here is that your child builds a savings account from the money they earned from you so that their tuition can be paid.
Obviously, the more properties you own the more you can pay them, but what you really want is to keep their earnings under their taxable limits. While the numbers can change a child can earn nearly $6,000 a year without paying any taxes at their income level.
Therefore, (using easy numbers) if they work for you and you pay them $5,000 per year they will have $25,000 every five years for college that you were able to move to them for work rendered and written off on your returns.
According to the Eller case (Eller vs Comm., 77 T.C. 934, Acq. 1984-2 C.B. 1) a child can be employed by you starting at the age of seven. That gives them 11 years of work until they turn 18 or $55,000 at the $5,000 per year example that we've used.
Defining the Work
Now, in order to be in compliance your child must work. You can't just pay them and they not do anything. So, when we are talking about work, what it is they can do?
Really there are a lot of things such as mowing the lawn or any other yard maintenance, painting, repairs (a great opportunity to teach them how to fix things), they can also do clerical work related to your rental properties such as shredding documents or work on your computer. I think you get the idea.
Because it is your child, you are paying a reasonable wage, your child is under 18, and you are not incorporated you don't have to pay social security or unemployment tax. But paying a reasonable wage is critical and your child must actually do the work.
If they are mowing the yard and you are paying them $50 per hour that would not be considered reasonable. What you pay them needs to be realistic in terms of the work they are doing.
Think about this for a moment. You have some rental properties and you hire your child and you deduct $5,000 for their labors. You then get audited. Would you believe that you paid your child this money to work? Probably not! Therefore, you want to be able to document their work.
You can document their work by making sure the following is done:
- Always pay them by check
- Have them complete a time sheet showing time/date worked and work accomplished
- Make sure the amount paid is reasonable for the work done
- Error on the side of extra details and make sure it is in a written format not digital (you can keep track of it on the computer but make sure you print it out and keep hard copies)
When actually setting up this type of a system it is advisable to consult with your tax professional first.