When talking about financial situation of a business?

Convoluted Tax & Domestic Help Situation.....Help?

• I'll keep this as brief as possible, but it's a pretty odd situation: I own a small business (sole proprietorship) that I run from my home. My adult daughter, son-in-law, grandson, son and son's girlfriend are all currently living with me. My daughter pays my son's girlfriend to babysit for her son while she works for me in my business. Questions: How should the payments for childcare to my son's girlfriend be handled? If my daughter claims the childcare expenses on her tax return, then the girlfriend has to claim it as income, making her a contractor - and responsible for the employment taxes. Girlfriend will only be making $4800 a year, so we're not talking even minimum wage here - more like a payment-in-kind situation, where she lives with us, doesn't pay rent, but babysits for a reduced rate so my daughter can work. I don't want to put the girlfriend in a situation where she has to pay taxes out of her pocket on that money, so I'm wondering if I should pay her as an employee of my business and take the taxes out...but then that changes the childcare situation in terms of my daughter paying her and being able to claim the childcare expense on her taxes - so that doesn't seem like a solution, either. Part 2: Can *I* claim last year's childcare expenses on my taxes, if I don't claim my grandson as a dependent? He lived here most of the year, and I provided his support for about half the year, but then daughter got married, moved out, and then all 3 of them moved back in a couple of months later. I paid about $2000 in daycare for my grandson out of my own pocket while he lived here. I am not claiming him as a dependent, because my daughter got married in October, and her husband has been providing their support since then. I just want to handle this properly, so we don't end up having any issues with the IRS. I realize it's not your average situation. This is just the first time I've been in a situation like this. I'd appreciate any knowledgeable help that can be offered.

• Answer:

  Let's strip it to the essentials. The girlfriend is NOT a contractor. She is an employee. BUT she is not an employee of the business. Everybody lives with you. The girlfriend is getting paid to babysit. While it's your home, she's your daughter's employee. If your daughter paid her more than $1700 in 2011, she was required to withhold fica/mc AND issue a W-2. Your daughter would report the taxes paid on a schedule H attached to her 1040. Since you are also paying her with free rent, that money ALSO needs to be reported on the W-2 with a schedule H attached to your W-2. As for who can claim the childcare on their taxes, only the taxpayer who both claims the child and paid the childcare can list it on their return as a childcare expense.