Hi, 

I would like (for reasons I don't need to go into here) to set up a
formal contract with my wife in which I will pay her a fair market
price in return for providing childcare for our children.  We are
happily married and residing together, so this does not fall under
divorce tax laws (alimony, child support, etc.).  I just want to make
explicit the actual value of the services she provides in caring for
our children full time.

My question is this:  Will she owe federal income taxes (in the U.S.)
on the money I pay her?  We can assume the funds could be construed as
either employee wages or independent contractor payments (doesn't
matter to me).  I know that the money I pay her would not require
payment of employment taxes (FICA, etc); despite the fact that she
could be construed as a household employee and subject to the "nanny
tax," the IRS makes an explicit exclusion from *employment taxes* for
household employees who are spouses.  HOWEVER, I can't find where or
if the IRS (or other authoritative source) says if *income taxes* are
due on the payments to her.  As you can imagine, having to pay income
taxes would be a very big financial hit!!

Please note the following additional info, if you find it useful to
bound the problem:  (1) I will not be paying this out of a business
account, but merely as a private individual.  (2) This arrangement is
not intended in any way to change my tax liability---I realize that if
it just a tax gimmick or shelter, the IRS would be able to collapse
the transactions and assess taxes as if we had no contract.  The
purpose of contract is quite apart from any tax implications, and all
I want to do is make sure it doesn't change
my tax situation as an unintended consequence.  (3) Also, I do not
qualify for the childcare tax credit, in case you need to know (thus,
her income from childcare will not be offset at all by my paying for
childcare). (4) Finally, I am a resident of Massachussets, which is
NOT a community property state.

***************
So, will my wife owe income taxes or not on wages or payments I make
to her for work in our home??  If you can find me a reference to an
authoritative source on this topic (IRS, tax court, US Tax Code,
etc.), you've earned yourself a payment!

---

Clarification of Question by massdude-ga on 18 Jan 2006 11:03 PST

In response to daniel2d-ga's comment: 

Thank you for responding!!  I appreciate the effort.  Here is my
understanding of the issue:

Of course what I am describing is not an arms length transaction, but
there is, as far as I know, nothing to say I "can't do it"!!  There is
nothing illegal about hiring your cousin to mow the lawn or your son
to work in your business. (In fact, the arrangement I am describing is
exactly what is happening already in my home and millions of others
across the country; we exchange goods and services with one another
within our home---goods and services that if they were exchanged with
outside parties would be taxable transactions whether cash was
involved or not.  I just want to make it explicit and put it in
writing.)

So, I'm not asking if I can do it--I'm quite sure I'm allowed to give
my wife money for what she does if I want to!  The question is, "What
are the tax implications?"   If you are suggesting the transaction
would be ignored by the IRS for not being arms length, that's fine. 
But please point me to an authoritative document, court case, IRS
ruling, etc that says so if you can find one.

Thanks for your help!

Can't do it.  You can't get paid to watch your own children.  That
would be like her paying you to do maintenance around the house.  That
woudl not be what they call "an arms length transaction".

This must be the silliest GA question ever.  You should be taxed just for asking it.

I think the previous comments are on the wrong track.  #1 you can pay
anyone to do anything you want as long as it is legal.  #2  The
deductibility of that payment to you has nothing to do with the fact
that it is income to the payee.

Your wife would have income and would have to pay income tax on it. 
If it's not income, its a gift.  Those are the only two choices.  If
it's a gift, then the unlimited marital deduction for gift tax
purposes means that there is no tax issue.  If it's income then she
has to pay tax on it.

Now, just because she's paying tax on it doesn't mean you get a
deduction for it.  You need to find a specific section in the Internal
Revenue Code that allows you to deduct those expense.

Perhaps you could, but what would the purpose be.  The definition of
income is money obtained from any source whatsoever, subject to a
number of exceptions.  However, you get taxed on your money, and she
will get taxed again, so except for some minor relief you might get
from deducting a portion of childcare costs, what would be your
impetus for such a transaction?

Do you file a joint return? If you do, the IRS won't care one way or
another because the only other consideration is FICA taxes, which you
already know don't apply. The reason that Publication 15 (which is
where you may have found the exception to FICA) makes no reference to
income tax witholding is that the IRS considers income to be shared
for those filing a joint return. If you file separately and the deal
is structured in such a way that she must report all the income you
"pay" to her, then the income she is "paid" will not be deductible for
you and taxed twice. My recommendation is that you "gift" her the
amount related to her services. This would result in no income tax
consequences.