Lessons From a Current IRS Audit

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If you don’t understand the unique tax issues affecting your family child care business, you may not get any help from your tax preparer and even the IRS!

A family child care provider who is now being audited by the IRS is finding this out and faces a $10,000 tax bill.

When a family child care provider hires a tax preparer, she expects that person to understand her business and file an accurate tax return on her behalf.

If she gets audited, she expects the IRS auditor to understand her business. And, if she hires a new tax preparer to defend her in the audit, she expects the new tax preparer to understand her business.

Here’s what happened when her two tax preparers and the IRS auditor didn’t fully understand all of the unique tax issues affecting family child care providers.

This week a family child care provider emailed me for help regarding her IRS audit. Later in the week I spoke with the tax preparer who is defending her in the IRS audit.

I was able to identify five areas that her two tax professionals and the IRS auditor had missed. They involved issues that will help significantly reduce the amount the provider will owe the IRS.

Issues

Exclusive use rooms: This provider had a basement area used exclusively for her business, but her tax preparer only counted it as space used regularly. This resulted in a much lower Time-Space Percentage than it should have been.

Family child care providers are entitled to count rooms used exclusively for their business as well as rooms used regularly for their business. See the Instructions to IRS Form 8829 Expenses for Business Use of Your Home, page 2 under the heading, “Special Computation for Certain Daycare Facilities.” It describes how to calculate your Time-Space Percentage if you have both exclusive use rooms and regular use rooms. This provider will be able to significantly increase her Time-Space Percentage because of her exclusive use space. Here’s an article I wrote about this issue.

Garage: This provider had not included her garage in the total square feet of her home nor counted it as regular use space for her business. The IRS Child Care Provider Audit Technique Guide clearly states that garages (even if detached from the home) must be counted as part of the home. Because this provider uses her garage to store day care items as well as household items (garbage can, yard tools, etc.) she is entitled to count this as regular use space. Since she had several rooms in her home that were not used regularly for her business, adding the garage will increase her Time-Space Percentage.

Car loan interest: Many providers are not aware that they can deduct the business portion of their car loan interest, even if they are using the standard mileage rate to claim expenses associated with their car. See IRS Publication 463 Travel, Entertainment and Gift and Car Expenses, page 16. Her tax preparers and the IRS missed this deduction.

Depreciation of property owned before the business began: Most providers do not realize that they can depreciate their furniture, appliances and many other household items that they owned before their business began. If they haven’t done this, they can go back and recapture all previously unclaimed depreciation on their current tax return, using IRS Form 3115. See the IRS Child Care Provider Audit Technique Guide for further information. Here’s an article I wrote about this issue.

Hours worked when children are not present: Most providers work a lot of hours before and after children are in their home on business activities such as cleaning, activity preparation, meal preparation, time on the Internet, record keeping, etc. Few providers keep accurate record of these hours that can increase their Time-Space Percentage. That is the case with this provider who is being audited. I gave her some advice about how she can try to reconstruct her records to make a case for the time she did work, but didn’t claim. Here’s an article I wrote about this issue.

One other issue

This provider’s original tax preparer made a mistake in not reporting as income the reimbursements she received from the Food Program. Money received from the Food Program is taxable income. When you deduct food expenses you can count the meals and snacks reimbursed by the Food Program.

Lessons

Tax preparers and the IRS should understand these unique issues affecting your business. But, as we see, they don’t always do so.

Therefore, it’s important for all providers to take a little time to learn these unique rules and bring them up to their tax preparer if necessary.

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I’ve made this easier for providers by including these issues, and many more, in my annual Family Child Care Tax Companion. This book is designed for providers who use tax preparers. If you share it with your tax preparer it can help you reduce mistakes and ensure that you pay no more tax than you should. The 2015 edition of this book will come out in early January 2016.

Tom Copeland – www.tomcopelandblog.com

Image credit: https://www.flickr.com/photos/lendingmemo/


Categories: IRS and IRS Audits, Record Keeping & Taxes, Time-Space Percentage

9 replies

  1. I am with the food program and my agency told me that I do not claim income from the food program, however you say differently. I’m confused.

    • IRS Publication 587 and the IRS Child Care Provider Audit Technique Guide both say that money from the Food Program is taxable income. If you give me the name and number of the person who told you not to claim it as income I will follow up with that person. If you didn’t report Food Program reimbursements as income and didn’t claim any food expenses as a deduction, then your tax return was not accurate, but it probably wasn’t too far off. If you received reimbursements at the lower Tier II level, then you were entitled to claim a much higher food deduction and you should amend your tax return. Call me at 651-280-5991 if you want further information.

  2. Thank you Tom for all you do! You are greatly appreciated and I hope you are told so often!

  3. Tom,
    You totally fascinate me on how available you make yourself to child care providers (myself included). I applaud you. Blessings,

    Sherri Roman from Trego Wisconsin

  4. Thank you so much for the help you provide to child care workers. We remodeled my home based preschool this summer. My kids come during the school year. Can I claim the time spent working on my building in my time/space percentage? The building in my backyard is used probably 90% or time for my school. Thanks

  5. I am sure there is a good reason, but why isn’t the 2015 edition of the Tax Companion available in January 2015 and the 2016 edition available in January 2016? I think it would be useful to use throughout the year. However, I am an R&R employee and haven’t purchased the book myself so maybe it would make more sense if I saw the contents. I encourage providers to purchase this resource frequently, so maybe I need to buy a copy.

  6. how do you claim items that were bought with cash from yard sales etc where receipts are not given.