Dear Readers -- My recent series of columns on Roth IRAs for kids generated so much response that it's worth taking another column or two to answer some of your follow-up questions. Here's the first installment.Question -- In your column you stated that payments for chores kids do around the house would be laughed at by the IRS. I opened a Roth IRA for my ward in 1997 for $520, a weekly allowance for doing chores around the house, added $590 in 1998 and $1,000 in 1999. The allowance was recorded in a weekly planner. Am I now to understand that what I have done is not legal?
Answer -- Let me be perfectly clear about this. While the IRS has not issued much official guidance on this subject, it's the consensus of tax professionals that neither allowance nor payment for chores that kids typically do around the house count as "earned income" for purposes of opening a Roth IRA.
The IRS would be unlikely to challenge relatively small amounts of money in such a gray area, so you could probably leave your ward's existing Roth in place. But don't make additional contributions until he or she is able to be compensated in a way that more closely fits the definition of earned income.
That would mean a more formal work arrangement at home -- such as being employed by a family business -- or doing jobs for other families. In that case, your ward should still keep careful records of work completed and payment received because no official Form W-2 would be involved.
Question -- According to your column, money can be gifted to a child to open a Roth IRA. My question: How much money up to the $2,000 limit can serve as the gift portion of the child's IRA?
For instance, if my daughter earned $500 baby-sitting and has paid Social Security tax on her earnings, can I give her the other $1,500 to open the Roth?
Answer -- Sorry, but you can only make a gift equal to the amount of a child's earned income (up to the $2,000 limit).
In your daughter's case, this would mean a maximum gift of $500 -- equal to her earnings as a baby-sitter.
Note: Your daughter does not owe Social Security tax on her income because baby-sitters under age 18, who are usually considered employees, are exempt from the tax on self-employed individuals.
Have a question about kids and finances for Dr. Tightwad? Write to Dr. T at 1729 H St., N.W., Washington, D.C. 20006. Or send the good doctor an e-mail message (and any other questions for this column) to jbodnar@kiplinger.com.