A recent Safe Harbor rule allows all home-based businesses, including child care providers, to claim up to $1,500 in house expenses on their 2013 tax return without receipts.
However, the instructions to Schedule C limit the amount that family child care providers can claim under this rule.
This new rule is voluntary.
Providers who use the rule cannot claim any house expenses on IRS Form 8829 Expenses for Business Use of Your Home. These house expenses include property tax, mortgage interest, house insurance, utilities, house repairs, house rent, and house depreciation. Providers who use the rule can claim 100% of their property tax and mortgage interest as an itemized deduction on Schedule A.
Under the new rule, home-based businesses can multiply the square footage of their home they use for their business (up to a maximum of 300 square feet) by $5, for a maximum deduction of $1,500.
This deduction is claimed on Schedule C, line 30.
However, the instructions to Schedule C require family child care providers to first multiply the $5 by their Time percentage. This sum is multiplied by up to 300 square feet to determine the allowed house expense.
Virtually all child care providers would be able to count 300 square feet in their home that are used on a regular basis in their business. See my article for further information on how to determine how many square feet in your home meet this test.
Here’s an example of how to claim house expenses under the new rule:
Let’s say a provider cares for children 11 hours a day, five days a week, 50 weeks a year (11 hours x 5 x 50 = 2,750 hours). In addition, she works 10 hours a week on business activities when children are not present (10 hours x 50 weeks = 500 hours). Total hours worked in a year: 3,250 (2,750 + 500 = 3,250). 3,250 business hours divided by 8,760 total hours in the year = 37% Time percentage.
$5 x 37% Time percentage = $1.85 x 300 square feet = $555 house deductions that can be claimed on Schedule C, line 30, under the new IRS Safe Harbor rule.
This clarification significantly reduces the amount of house deduction providers can claim under the Safe Harbor Rule. As a practical matter, the vast majority of providers will not benefit by using the rule.
Providers can determine whether or not the rule will benefit them by comparing their house expenses on line 35 of Form 8829 with the amount they could claim on Schedule C, line 30.
For example, a provider with a typical Time percentage of 40% would be entitled to deduct $600 of her house expenses on Schedule C under the new rule ($5 x 40% = $2 x 300 square feet = $600). This provider would only choose this new rule if her total house expenses on Form 8829 were below $1,500 ($1,500 x 40% Time-Space Percentage = $600).
Since most providers have house expenses well above $1,500, this new clarification will mean that only a few providers with very low house expenses can benefit from it.
Note: If you have an exclusive use room that is at least 300 square feet, you won’t have to reduce the $5 amount by your Time percent. Thus, you could claim the maximum of $1,500 in house expenses. However, for most providers this still would be less than they could claim using Form 8829.
All regulated, licensed or license-exempt providers can use the Safe Harbor rule.
If you choose not to use the Safe Harbor rule, fill out Form 8829 as usual and transfer your business house expenses from line 35 to Schedule C, line 30. Do not fill out the two lines of information asked under “Simplified method filers only.” Do not use the Simplified Method Worksheet found in the instructions to Schedule C.
If you use the Safe Harbor rule on your tax return, you cannot later amend this portion of your tax return. You can choose each year whether or not to use the Safe Harbor rule.
If you purchase items that qualify for the Section 179 rule, you can still use this rule even if you use the Safe Harbor rule.
If you first started using your home for your business after January 1 of the year you are filing your taxes, you must calculate an average monthly allowable square footage by adding the amount of your regular use space (no more than a total of 300 square feet) used each month and dividing the sum by 12. For example, if you used 300 square feet from August through December, your allowable square feet is 125 (5 months x 300 square feet = 1,500 square feet divided by 12 months = 125). Therefore, a provider with a 40% Time percentage would be able to claim only $250 in house expenses ($5 x 40% = $2 x 125 square feet = $250).
If you moved during the year and used two homes for your business you may elect to use the Safe Harbor rule for only one home. Therefore, you could either fill out one Form 8829 for each home, or fill out Form 8829 for one home and use the Safe Harbor rule for the other home.
If you have carryover house expenses from your Form 8829 from an earlier year you cannot roll them over to your current tax return if you use the Safe Harbor rule. You can roll them over to a later year when you use Form 8829.
If your spouse uses your home for a separate business, each of you can elect (or not) to use the Safe Harbor rule for your separate portions of the home. However, the maximum number of square feet you can both use is 300.
If you rent your home you cannot use the Safe Harbor rule.
The instructions to Schedule C refer to additional information about using the Safe Harbor rule in IRS Publication 587 Business Use of Home .
I am extremely disappointed by this new clarification.
After the Safe Harbor rule was originally announced I gathered input from many child care providers and tax preparers and wrote a letter to the IRS. I recommended that they allow providers to count all of the square feet in their home that they used on a regular basis for their business. Doing so would make it possible for many more providers to take advantage of this rule.
I do not understand why the IRS decided to add this new clarification that makes it impractical for almost all providers to use the new rule.
For many years the IRS rules recognized that family child care providers could claim more house expenses than other home-based business because, unlike all other home-based businesses, providers used most, if not all, of their home. It doesn’t make sense to now reduce the house expenses providers can claim in comparison to all other home-based businesses (who don’t have to reduce the $5 by a Time percentage).
When the new clarification came out last week I wrote another letter to the IRS asking them to reconsider this change. I will continue to lobby the IRS to modify the Safe Harbor rule to allow more providers to use it.
The intent of the Safe Harbor rule was to reduce the record keeping burden of home-based businesses. Some tax preparers may be tempted to advise you to use the rule because it will also mean less work for them (they won’t have to file Form 8829). It is extremely important to make sure you do not let your tax preparer talk you into using it, unless you understand that it will benefit you financially. Therefore, ask your tax preparer to compare what you can deduct on Form 8829 (line 25) with what you could deduct under the new rule (Schedule C, line 30).
If a provider uses the Safe Harbor rule, how are they to determine how much of shared expenses (both business and personal use) they can deduct on Schedule C (toys, fence, furniture, appliances, etc.)?
I assume a provider would have to calculate her Time-Space Percentage on a separate piece of paper (rather than using Form 8829) and apply it to her shared expenses on Schedule C.
See my previous article about the Safe Harbor rule, here.
Tom Copeland – www.tomcopelandblog.com
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