Your Child Wins A Beauty Pageant

We are in a mini “tax season” here at Galactic Command, with September 15 being the deadline for business returns. Next month is the extended due date for the individual returns.

I wanted to find something light-hearted to discuss. Call it a salve to my sanity.

Let’s talk about your kid. Yes, the one who will soon be discovered on America’s Got Talent. It could happen. He could be the next Jonathan, or she the next Charlotte.

COMMENT: Jonathan and Charlotte were discovered on Britain’s Got Talent. It is worth watching their first appearance, if only for Simon’s reaction.

Say your kid wins prize money.

This being a tax blog: who pays tax on the money – the kid or you? After all, the kid is your dependent. He/she is nowhere near emancipated.

Here is a Code section one could spend a career in practice and not see:

 § 73 Services of child.

(a)  Treatment of amounts received.

Amounts received in respect of the services of a child shall be included in his gross income and not in the gross income of the parent, even though such amounts are not received by the child.

(b)  Treatment of expenditures.

All expenditures by the parent or the child attributable to amounts which are includible in the gross income of the child (and not of the parent) solely by reason of subsection (a) shall be treated as paid or incurred by the child.

The daughter of our protagonists (Lopez) started competing in beauty pageants at age nine. There were expenses involved with this, such as travel, outfits, cosmetics and so on. In 2011 and 2012 she won a couple of dollars, approximately $3,200 to pin it down.

Which was nowhere near the expenses of over $37 grand across the two years.

They used an Enrolled Agent with over 40-years’ experience to prepare their return.

COMMENT: An E.A. is an IRS-administered exam on tax proficiency. While perhaps not as well-known as the CPA, it is a substantial credential. There are many CPAs who practice outside tax, for example, but all E.A.’s practice tax.

The E.A. decided to put the daughter’s income on the parent’s return. He arrived at that conclusion by reviewing state child labor laws. He gave it a lot of thought, but he missed Code Section 73.

As I said, it is rare that one would blow dust off that section.

He prepared the parent’s return, including the daughter’s prize money.

That part was only $3 grand or so. The sweet part was the $37 grand in expenses. The parents took a BIG tax loss.

And the IRS tagged the return.

The Lopez’s fought the IRS. There was also a second IRS adjustment, so I presume they decided that fighting one was the same effort as fighting both.

The kid’s income and expenses, however, was a clear loser.  

The IRS adjusted their income by over $30 grand, so they came in with a souped-up penalty – the “accuracy related” penalty. That bad boy parachutes in at 20%. The IRS likes to toss that one out like hot-sauce packets at Gold Star.

Remember the E.A.?

The Court pointed out that the Lopez’s hired a tax professional. He researched the issue. Granted, he arrived at the wrong answer, but that was not the Lopez’s fault. They hired a professional, and they reasonably relied upon the advice of the professional.

The Court dismissed the penalties.

Small consolation, but something.