The first thing the IRS looks for in a family child care audit is unreported income.
The IRS knows that family child care providers tend not to keep good records and often get paid with cash. As a result, they assume that some child care providers don’t report all their income.
Here are some steps to follow to insure that you will have the adequate records of your income:
* Report on your tax return all income from parents, the Food Program, subsidy program, and grants.
* Keep records showing the source of all deposits into your checking or savings accounts (both business and personal). Indicate on a deposit slip, check register, software program, or other record where the money came from (husband’s pay check, business deposit, transfer from savings, etc.). The IRS likes to look at bank deposits and compare them to what you reported as income. If you can’t identify where all the money came from for each deposit the IRS will assume the unidentified deposit is business income.
* If you receive cash from parents and don’t deposit all of it in a bank account, make a note on a ledger or your calendar of how much you received and how much you deposited.
* The IRS will initially assume that a child is enrolled in your program for 52 weeks a year at your full time rate. They will look at your contract to identify your rates. For example, if your rate is $150 a week, the IRS will assume you earned $7,800 a year ($150 x 52 weeks = $7,800) to care for one child. You need to keep attendance records showing when a child was not present (sick day, vacation, holiday, etc.) and if the child was part-time for all or part of the year.
* If your rates change in the middle of the year, or you don’t charge the parent your full rate (because of an family layoff or illness), keep records to show that you did not receive your full-time rate for this child.
Here’s an example: You care for a child for 52 weeks and the child is on the Food Program. But, because of a layoff in the child’s family, you decide to charge the family half your regular rate for three months. The IRS will look at your Food Program records and attendance records to see that the child is present for the entire year. They will then assume that you were paid your full rate for the year. You need to show with your parent payment records that the parent paid less for those three months.
* If your contract says you charge for a late pick-up fee, or for overnight care, be sure that if you don’t charge for any of these fees your records show this. In other words, if your attendance records show that the child was picked up at 7pm and your contract says the pick-up time is 6:30, with a $1 a minute late fee, the IRS will assume that you earned an extra $30 each day this happened. If you are not charging parents for these late pick-ups put a note in your attendance records (“No late fee charged”).
* Give parents an end-of-year receipt of the total amount the parent paid you for the year and ask them to sign a copy for you to keep in your files.
Keeping track of your business income throughout the year will pay off when you do your taxes by saving you a lot of time. Having good records of your income will also help you if the IRS decides to audit you.
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For more information about recording your income, see my book Family Child Care Record Keeping Guide.