May 30, 2018 11:47 pm

Payments on Behalf of Children Weren’t Deductible Compensation

A mother ran a consulting business that provided services to various federal agencies through contract labor. She had two children in college, and she paid for their tuition and related education costs as well as housing, cars, meals, entertainment, and substantially all other expenses for them, most of which were covered through the use of her credit card. She had them perform some services for her business, including graphic design services, administrative services, and delivery services. She deducted the costs for her children on Schedule C, arguing that they were payments for their work.

The Tax Court denied her any deduction related to her children (Harlan Wax, TC Memo 2018-63). She did not keep track of the hours her children worked or the services they performed, so the expenses paid on their behalf could not be characterized as bona fide or reasonable compensation. The court pointed out that where a family relationship is involved, close scrutiny applies to determine whether payments to or on behalf of a taxpayer’s children are on account of an employment relationship or a family relationship, and whether the amounts paid are reasonable for the work performed. In this case, it did not help that the mother’s testimony was “tainted by far-fetched rationalizations.”

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Tax Glossary

Real estate professional

An individual who, because of his or her real estate activity, qualifies to deduct rental losses from nonpassive income.

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