Child Labor: work permits, OT, articles of incorporation and more.

• Author: Williams, Leonard W.
• Position: CaliforniaTax

Business owners who hire and pay their children can deduct the wages as a business expense, just as they would for any other employee.

For a child under 18 working in the parent's unincorporated business, there is the added advantage that the business owner doesn't have to deduct or pay Social Security taxes, SDI or unemployment insurance on those wages.

Depending on the amount paid, income tax withholding may be required. The business owner must keep records of hours worked and the hourly wage has to be rational. For example, paying a 15-year-old $100 per hour for emptying waste baskets is not rational.

The biggest problem with clients is that they think that there is some arbitrary amount that they can put onto their kids' W-2s, regardless of whether or not the child actually worked or at what rate of pay.

This attitude has been around for years, but it has received a boost recently by non-CPA tax advisers who tell their clients that they have an intrinsic right to show arbitrary amounts on their business income tax returns as expenses for wages paid to their children. While none of this is new to experienced readers, the next point may be.

Income tax auditors now generally ask for the work permits of the business owner's minor children who are shown as employees. For those of us who have forgotten that work permits exist, or didn't know in the first place, here is a brief explanation.

A school-age minor who works as a paid employee must get a work permit from the school. The controlling California statute is Labor Code Sec. 1394. The minimum age to receive a work permit is 12 for California purposes and 14 for federal purposes.

Labor Code Sec. 1394 is clear that a work permit is not required for agricultural, horticultural or domestic work. However, the part that seems to pertain to other family owned business is unclear.

Some say that the wording exempts family-owned businesses, but income tax authorities are interpreting the Labor Code as saying that employment in other than agricultural, horticultural or domestic work is not exempt from the work permit requirement.

The lack of clarity brings to mind the great legal principle: Factum Clarum, jus nebulosum--The clearer the facts, the more muddled the law.

The attorneys who participate on TaxTalk agree that if the IRS and FTB interpretation is that children working outside of the above three areas must have work permits, then it's probably best to get the work permits.

One CPA's story...