Notes on the following letter sent by the IRS to Senator Rudy Boschwitz on February 6, 1990:
This IRS letter was written in response to a letter from former Minnesota Senator Rudy Boschwitz, who asked for a clarification on seven issues facing family child care providers.
Issue One: This letter clearly indicates that providers may count hours spent cooking, cleaning, and preparing activities for their business as part of their Time-Space calculation.
Issue Two: This letter indicates that whether a trip is primarily business or personal depends on the facts and circumstances of each case. Notice, however, that a trip can have some personal activity and still be considered a business trip. Some IRS auditors have said that if a trip has any personal activity, it cannot be claimed as a business trip. This is not true.
Issue Three: A provider who does not make a profit in three out of five years will not automatically be determined to not be in the business for profit.
Issue Four: The IRS is looking much more closely at Form 2441 to see if child care expenses and income match. A parent may not claim a child care tax credit if the provider is a dependent care center and does not comply with all state and local laws. A dependent care center is defined as someone caring for more than six children (not counting the provider’s own children). In other words, a provider caring for six children or less can be illegal, according to local law, and the parent using this provider can claim the child care tax credit.
Issue Five: This letter does not answer the question of whether or not Food Program sponsors must issue Form 1099-MISC to their providers. But another letter from Michael Gallagher of the IRS does say that sponsors are not required to issue this form.
Issue Six: Capital expenses incurred to comply with licensing requirements must be depreciated and cannot be expensed in one year. If the expense if for personal property (i.e. fire extinguisher) and the business-use percent is over 50 percent, the item may be claimed as an expense in one year under Section 179 rules.
Issue Seven: The monthly base charge of a telephone is not deductible, even for a provider who is required to have a phone by child care licensing rules.
Letter to Rudy Boschwitz:
February 6, 1990
The Honorable Rudy Boschwitz
United States Senate
Washington, DC 20510
Dear Senator Boschwitz:
This is in reference to your letter dated December 15, 1989, in which you ask a number of questions regarding the tax consequences under the Internal Revenue Code to child care providers, to taxpayers using the services of child care providers, and to food program sponsors.
Your first question concerns the deductibility of expenses for the business use of a home for providers of day care. Specifically, you ask whether hours spent cooking, cleaning, and preparing activities for the business of child care may be included in the calculation of the Time-Space Percentage.
Section 162 of the code provides, in general, that a deduction is allowed for the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Whether an expense is ordinary and necessary and whether an expense is incurred in the conduct of a trade or business is largely a question of fact.
Section 262 states, that except as otherwise expressly provided, no deduction shall be allowed for personal, living, or family expenses.
Section 28OA(a) of the Code states, in general, that except as otherwise provided, in the case of an individual, no deduction otherwise allowable shall be allowed with respect to the use of a dwelling unit that is used by the taxpayer during the year as a residence. Section 28OA(c)(4)(A) provides, in part, that subsection(a) shall not apply to any item to the extent that the item is allocable to the use of any portion of the dwelling unit on a regular basis in the taxpayer’s trade or business of providing day care for children.
Section 28OA(C)(4)(C ) of the Code indicates that if a portion of the taxpayer’s dwelling unit is not used exclusively for child care, the amount of the expenses attributable to that portion of the dwelling shall not exceed an amount that bears the same ratio to the total amount allocable to such portion as the number of hours the portion is used for such purposes bears to the number of hours available for use. This Time-Space Percentage limits the amount of the deduction available to taxpayers based on the number of hours the dwelling is used exclusively for child care and the number of hours it is available for other use. A copy of Publication 587, Business Use of Your Home, is enclosed for your information.
House spent cooking, cleaning, and preparing activities for the business of child care could be included in the calculation of the Time-Space Percentage if the tests for deduction under section 162 of the code are otherwise met under the facts of the particular case. For instance, if a child care provider spends one-half hour setting up for the children and one-half hour returning a room to personal use, in addition to seven hours actually in the presence of the children, a provider could claim that eight hours were expended in the trade or business of providing day care for children. As with any business use of a home, care providers must substantiate claims for hours expended in the conduct of the trade or business of providing child care. Publication 552, Recordkeeping for Individuals, and Publication 583, Taxpayers Starting a Business, provide information for taxpayers on how to keep adequate books and records for tax purposes. We have enclosed both publications for your information.
Section 6001 of the Code provides that every person liable for any tax shall keep records as prescribed by the Secretary of the Treasury. Section 1. 600 1 -I (a) of the Income Tax Regulations provides that every person subject to income tax shall keep permanent books of accounts or records as are sufficient to establish the amount of gross income, deductions, credits, or other matters.
Your second question concerns the business use of a car by child care providers. Specifically, how many miles may be deducted when a provider drives to a store to buy items for both business and personal use.
Section 1. 162-1 of the regulations provides that business expenses deductible from gross income include operating expenses of automobiles used in a trade or business. Section 1. 162-2(b) provides that if a taxpayer travels to a destination and engages in both personal and business activities, traveling expenses to and from such destinations are deductible only if the trip is related primarily to the taxpayer’s trade or business. If the trip is primarily personal in nature, the traveling expenses to and from the destination are not deductible even though the taxpayer engages in business while at such destination. Whether a trip is related primarily to the taxpayer’s trade or business or is primarily personal in nature depends on the facts and circumstances in each case. The amount of time during the period of the trip that is spent on personal activity compared to the amount of time spent on activities directly relating to the taxpayer’s trade or business is an important factor in determining whether the trip is primarily personal.
If an automobile trip is primarily for business, a taxpayer may deduct actual expenses or use the standard mileage rate, depending on the facts and circumstances. The enclosed Publication 917, Business use of a Car, explains the deductible expenses. This publication also discusses what records must be kept to substantiate vehicle expenses, including the cost or other basis of the vehicle and the number of personal and business miles driven during the year.
Your third question concerns whether a child care provider is considered to be engaged in an activity for profit. Specifically, you question whether a child care provider who does not show a profit in three of five years automatically becomes classified as not in the business for profit and therefore becomes ineligible for business deductions.
Section 183 of the Code provides, in the case of an individual, if an activity is not engaged in for profit, no deduction attributable to the activity shall be allowed except as provided. Section 183(d) establishes a presumption that if gross income exceeds the deductions for an activity in three of five consecutive taxable years, the activity shall be considered engaged in for profit.
Section 1. 183-1 of the regulations provides that whether an activity is engaged in for profit is determined under section 162 of the code and section 212(l) and (2) except insofar as section 183(d) creates a presumption that the activity is engaged in for profit. If deductions are not allowable under sections 162 and 212(l) and (2), the deduction allowance rules of section 183(b) and the regulations apply.
Section 1. 183-2(a) of the regulations defines the term “activity not engaged in for profit” as any activity other than one with respect to which deductions are allowable under section 162 of the Code or under paragraph (1) or (2) of section 212. The determination of whether an activity is engaged in for profit is to be made by reference to objective standards, taking into account all of the facts and circumstances of each case.
Section 1. 183-2(b) of the regulations provides that in determining whether an activity is engaged in for profit, no one factor is determinative. The section lists objective factors that should normally be considered, including the manner in which the taxpayer carries on the activity, the expertise of the taxpayer or his advisors, the time and effort expended by the taxpayer in carrying on the activity, and the taxpayer’s history of income or losses with respect to the activity. Section 1. 183-2(b)(1) states that the fact that the taxpayer carries on the activity in a businesslike manner and maintains complete and accurate books and records may indicate that the activity is engaged in for profit.
Since section 183(d) merely establishes a presumption that favors the taxpayer if income exceeds deductions in three of five years, a child care provider who does not show a profit in three out of five years will not automatically be determined to not be in the business for profit.
Your fourth question refers to the credit available to taxpayers using the services of child care providers under section 21 of the Code for expenses incurred for child and dependent care. Specifically, you ask whether parents may claim the child care credit if they use a child care provider who does not meet state and local standards.
Section 21 of the code provides, in part, that an individual who maintains a household that includes one or more qualifying individuals shall be allowed as a credit an amount equal to the applicable percentage of the employment-related expenses paid during the tax year. The amount of credit is subject to both dollar and earned income limitations. Section 21 (e) outlines special rules for taking the child and dependent care credit.
If the service provider is a dependent care center as defined in section 2 1 (b)(2)(D), payments made to such a care provider shall only be taken into account for purposes of the credit if the center complies with all applicable laws and regulations of a state or local government. Thus, parents may not claim a credit for payments made to a dependent care center unless the center complies with all applicable laws and regulations of state and local governments.
There is currently no requirement that other care providers comply with applicable state and local standards before a parent may claim the credit for expenses paid to the care provider. However, a care provider who does not comply with the provisions of applicable state laws will be ineligible for a deduction under section 28OA(c)(4)(B) of the Code for business use of a home.
Beginning in 1989, taxpayers claiming a credit under section 21 of the code must include on their tax return the name, address, and taxpayer identification number of the child care provider. A copy of Publication 503, Child and Dependent Care Expenses, is enclosed for your information.
Your fifth question concerns information reporting requirements of sponsors of the Child Care Food Program. Specifically, you question whether food program sponsors are required to issue Forms 1099 to participating child care providers.
To assist the Internal Revenue Service in ascertaining whether taxpayers have correctly calculated their tax liabilities, the law requires certain persons to file information returns. Generally, these information returns are required to be filed by persons who make payments to others in the course of their trade or business. The information returns filed with the Service are matched with the payees’ income tax returns to detect the nonfiling or underreporting of the income.
Section 6041 of the code provides, in part, that all persons engaged in a trade or business making payments to another person of $600 or more in a taxable year are required to make information returns regarding the payments as prescribed by the Income Tax Regulations. Section 604 1 A requires a recipient of services to report payments made to a provider of services if the remuneration in a calendar year is $600 or more. The information return used to report such payments is Form 1099-MISC, Statement for Recipients of Miscellaneous Income.
Whether a particular food program sponsor must file a Form 1099 depends on whether the section 6041 tests, and particularly the trade or business test, are met in that case.
Your sixth question asks if a care provider is required by state or local law to modify the home to become licensed or certified, are these modifications repairs or improvements. This question concerns whether expenses incurred in modifying a residence to comply with licensing requirements are capital or deductible expenses.
Section 262(a) of the Code states, in part, that except as otherwise provided, no deduction shall be allowed for personal, living, or family expenses. Section 263 disallows a deduction for capital expenditures. A capital expenditure includes any amount paid for permanent improvements or betterments that extend beyond the tax year made to increase the value of a property or estate.
Section 1.263(a)-I(b) provides, in part, that the disallowance for amounts paid for betterments or improvements include amounts expended to adapt property to a new or different use. In RKO Theaters, Inc. v. U.S., 163 F. Supp. 598 (Ct. Cl. 1958), a theater corporation was required to construct new exit facilities and fire escapes as a condition to the granting of a future license. The court held that even though the changes did not prolong the life of the theater or increase its value, the expenses were nevertheless permanent capital improvements and the expenditures had to be capitalized.
Although a capital expenditure may not be deducted, a taxpayer may be able to recover this cost by taking annual deductions for depreciation. We have enclosed Publication 534, Depreciation, for your information.
Your final question concerns the deductibility of telephone expenses. Specifically, is any portion of the monthly base charge of a telephone deductible if a child care providers are required by law to have a telephone. Section 262(b) of the code provides, in the case of an individual, that any charge for basic local telephone service with respect to the first telephone line provided to any residence of the taxpayer shall be treated as a personal expense. Section 262(a) provides that a personal expense is not deductible.
In a November 13, 1989, meeting with members of your staff, these and other questions we discussed in detail. It was agreed that many of your constituents have been misinformed as to the deductions available to, and the responsibilities required of, child care providers in your state. We have enclosed a copy of Publication 1224, Free IRS Community Outreach Tax Assistance, for your information.
The Community outreach program, which is one of the Internal Revenue Service’s volunteer and education programs, is managed by the Taxpayer Service Division. Under this program, Service employees or trained volunteers conduct tax education seminars on a variety of topics for groups of individuals with common tax interests and provide group self-help tax return preparation.
During fiscal year 1989, the St. Paul District conducted nine tax education seminars on dependent care providers. These seminars were attended by 344 individuals. Additional seminars addressing the topic are scheduled for 1990. For specific information on the times and places for these seminars or if you would like to discuss scheduling a seminar, we invite you contact the Taxpayer Education Coordinator in the St. Paul District by calling the number or writing to the address shown in Publication 1224. We hope the information provided is of help to you. If we can be of further assistance in this matter, please contact Cynthia Davis of this office.
Earnest L. Kennedy
Acting Assistant Chief Counsel
Income Tax and Accounting
Internal Revenue Service