In 2005 Tom Copeland received more requests for help from providers who were audited than ever before. Nationally, the IRS is conducting a greater number of audits than in earlier years, although we see no sign that they are auditing providers more often than other businesses. Here are some of the highlights of what we have seen:
The IRS often audits the number of hours that providers work. They particularly focus on the hours providers spend on business activities—such as cleaning, meal preparation, activity preparation, record keeping, parent interviews, etc.—after the children are gone. Some auditors tried to deny all hours that providers worked on these activities in the evening or on weekends, but several Tax Court cases and IRS publications clearly allow providers to claim these hours. Many providers do not keep adequate records of these hours and cannot support their claim in an audit. It is important to track on a daily basis these hours for at least two months each year to be able to support your claim.
The IRS also looks closely at basements and garages when they are included in the Space Percentage Calculation. Providers are clearly entitled to count such spaces if they are regularly used in their business, even if children do not play there. When providers are claiming that a room is used 100% for their business, they should take photographs and write down a typical daily use of the room to help support their claim.
Providers who buy a second freezer or a vacuum cleaner used only in an exclusive-use room are sometimes challenged in an audit. It can be tricky to prove that an individual item is only used for business purposes. Auditors sometimes argue that such items are probably used for personal purposes as well and will only allow the Time-Space percentage as a deduction. It can be difficult to prove that an item is not used personally, but often providers prevail by being persistent and insisting that certain items are used only for the business.
In Ohio a provider was overenrolled for about 10% of the year when she had one too many children in her program at the end of a number of days throughout the year. The auditor tried to assert that this meant she could not claim any house deductions on Form 8829: Expenses for Business Use of Your Home. Although the instructions to that form do say that an illegal provider cannot claim house expenses, this provider was simply overenrolled for a limited time. Eventually the auditor backed off and allowed 90% of the deductions for this form. The auditor also argued that because she was overenrolled she was not entitled to claim any depreciation expenses on Schedule C. The supervisor then stepped in and reversed this decision.
A provider hired her four children (ages 14, 13, 9, and 8) to do work for her business and paid them $5 a week in cash. She did not keep any records to show what work they did or how long they worked other than keeping a list of the “chores” performed. The auditor ruled that this was an allowance and not a business expense. Paying a flat amount each week does look like an allowance and the provider’s use of the word “chores” did not help her case.
A provider claimed a trip to Las Vegas as a business deduction because she went there to explore the possibility of moving to this town. But she was unable to show that the primary purpose of the trip was business, so she will lose this issue. The provider also tried to deduct the cost of her clothes, but this is considered personal and is not allowed. The auditor tried to deny the provider’s deductions for gifts to children, diapers and baby wipes by saying that the provider bought these “out of the kindness of her heart.” But, kindness has nothing to do with business deductions and these expenses should be allowed. Lastly, the auditor denied the cost of paying someone to mow her lawn because it is used personally, but such expenses are “ordinary and necessary” in the family child care business and are deductible.