Here’s an often-overlooked tax strategy that can generate substantial family tax savings when handled correctly. In fact, using a family payment tax strategy can help you maximize these savings. If you pay a family member (or even a non-relative) for a one-time project, the tax treatment can be highly favorable—but only if you follow the proper reporting rules.
For example, paying a college-aged child $23,255 for legitimate services can produce significant benefits. In one case, this created an $8,593 tax deduction for the payor, while the student owed only $713 in tax—resulting in a net family tax savings of $7,880. And of course, the student has the $23,255 from the family payment tax strategy.
But beware. What are three critical areas where mistakes commonly occur when implementing a family payment tax strategy?
1. Form 1099 Reporting
Unlike typical contractor payments, you do not report this income on IRS Form 1099-NEC. Instead, because it is not subject to self-employment tax, you report it in box 3 of IRS Form 1099-MISC. This distinction is essential in a family payment tax strategy.
2. Kiddie Tax Treatment
Although many assume the kiddie tax applies, it does not in this case. The income qualifies as earned income because it is payment for actual services performed. Kiddie tax rules apply only to unearned income (such as investment income).
3. IRA Contribution Opportunity
This earned income qualifies as “compensation,” meaning the recipient can contribute up to $7,500 (2026 limit) to a traditional or Roth IRA.
If you want to discuss this one-time project strategy, contact us today!