Can a non-W2 compensation of a minor be used to fund their Roth IRA?

I have two minor children who work. One has a regular W2 job, so she can contribute to a Roth IRA up to the amount earned. However, my other daughter primarily babysits. She earned about $1,000 this year. Obviously this is not a traditional wage in the W2 sense. However, is this compensation still eligible for her to start up and contribute to a Roth IRA? I've read the IRS definitions of compensation for IRA's but am still unclear.

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7 hours ago

You're definitely thinking about the right things.  A kiddie Roth IRA is an A+++ way to start saving and investing for a minor who has earned income.

The key to qualifying is that you have to declare the income on her tax return.  When someone is paid in cash for small odd jobs such as babysitting, etc., there is a question of whether to tell the IRS about it.  While the absolutely most scrupulous and precise thing to do is to declare the income on her tax return, if we're talking about $1,000 in cash paid for babysitting, in reality no one from the IRS is going to come after you for failing to report that.

Reporting that amount of babysitting income is effectively a choice.  If you report it (say, as "miscellaneous income"), you will pay some tax on the income.  If you are claiming your daughter as a dependent, then her tax return will roll up into yours and you will pay federal and state income tax on the $1,000 at your marginal tax bracket.  So you will have to pay a few hundred bucks in taxes all in all if you declare it.  Paying that tax gets you the ability to contribute to a kiddie Roth IRA for her because she will have had declared, earned income.  Compare and contrast to the other kid who has a regular W-2 job -- there, the income is automatically reported to the IRS, the taxes automatically withheld, and the decision effectively made for you.

It's not entirely clear what the right move is for you.  Pay taxes on the income to qualify for a kiddie Roth IRA, or just keep the extra $ in your pocket and don't tell the government about it.  It probably works out close to a wash, because it's the difference between paying tax now or paying tax later.  If you want to avoid paying taxes later and give her the maximum tax-free compounding of her savings, you'd pay the tax now, and do the kiddie Roth contribution.  If you wanted to avoid paying tax now, you could simply open a UTMA account for her (another good way to help her start investing at an early age) but any earnings over time in an UTMA account would be taxed, unlike in a Roth IRA where it compounds tax-free indefinitely.

Hope this helps.

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