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.
Surprising that there were some who answered "No" - this is incorrect. She CAN use cash income from babysitting as long as she files a tax return and reports the income. There is no requirement for a child to report this level of income, but you may choose to do so just for the purpose of demonstrating income for funding the Roth.
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.
Yes, and it is a great way to start early and the Roth is a wonderful way to go based upon these circumstances. These are known a Custodial Roths or Roths for Kids, Google it. As long your child has "earned income" - W2 or 1099 - it qualifies. Your daughter may need to file a tax return to demonstrate the income, but she will not owe any tax at that income level. You may want to consult with your CPA to determine the best course of action regarding the income.
Hope this helps and best of luck, Dan Stewart CFA®
The answer is no she is not eligible for a Roth IRA.
You need to have taxable income to be eligible for a Roth IRA, that means income that can be taxed.
If she received a 1099 for the babysitting that would be ok since it would make it taxable.
Her income is not reported in any way.
Good question and it is great that your children are thinking about starting to save early.
Unfortunately the situation you describe would not allow your daughter, who babysits, to make an IRA or Roth IRA contribution. This would need to be earned and reportable income for her to make a contribution to one of those accounts. She would need to have it as either W-2 reportable wages or have received a 1099 from the folks that she is babysitting for. My guess is that neither of those are happening and she is not claiming this income on a tax return.
Feel free to run this by your tax advisor if there are additional questions beyond what you outlined here. Good luck and good job teaching them young!