When family child care provider Phyllis Rosales of Kansas City, Missouri, was told by an auditor of the IRS over three years ago that she owed over $14,000 in taxes and penalties, she decided to fight back and call Tom Copeland for help. Last month Tom settled her case with the IRS and saved Phyllis over $8,000. The original auditor clearly did not understand basic family child care tax rules. She told Phyllis that she couldn’t deduct something if it had any personal use and denied deductions for cable television, house repairs, furniture and appliances, cell phone, Internet use, business interest on a credit card, and much more.
She also asserted that Phyllis had a Time-Space Percentage of 22% rather than the 46% claimed by the provider. She denied the business space use of the garage, the provider’s bedroom and her daughter’s bedroom as well as part of the basement. She also denied many business hours the provider worked after the day care children were gone. In addition, the auditor charged Phyllis over $2,400 in accuracy related penalties for “intentionally” disregarding rules and regulations. (The Tax Court lawyer threw out these penalties.) The provider made some mistakes on her tax return. She claimed 100% of the cost of household items such as a CD player, camera, dishwasher, computer, furnace cleaning, dryer repair, and garage door repair.
In the settlement, the IRS agreed that she was entitled to deduct her Time-Space Percentage of these expenses. Phyllis also deducted expenses related to her cat (food, litter, and vaccinations) that should not have been claimed. (In assisting providers over the past 20 years, I have never won a deduction for a dog or cat!) Here are some lessons that providers can take from this case:
Providers are entitled to claim their basement and garage as part of their Time-Space Percentage if they can show that these areas are used on a regularly basis in their business.
Phyllis worked an average of 16 hours a week after the day care children were gone doing activities such as cleaning, record keeping, activity preparation, etc. Although 16 hours is higher than most providers, Phyllis won because she kept a daily record of these hours on her calendar for each month of the year.
Most providers do not keep such complete and accurate records of the hours they work when children are not present. In my workshops and books I recommend that providers keep at least two months of such records. I still think this is a reasonable goal. But in this case where the provider worked such long hours, recording her hours for the entire year, made a difference.
In addition to the extra 16 hours a week, Phyllis also claimed another 297 hours spent studying at home to receive her Early Childhood Degree. Her degree was not deductible because it was her first post secondary degree. (Note: If providers already have a post-secondary degree and get a second degree, the cost of the second degree is deductible.) The IRS took the position that since the degree was not deductible, the hours spent studying at home could not be counted. I have not faced this issue before and we agreed not to count these hours. In the end the IRS allowed Phyllis to claim a Time-Space Percentage of 42.7%.
Phyllis had hired her 17-year old daughter and husband in her business and established a medical reimbursement plan that allowed her to deduct medical expenses for her business. She kept excellent payroll records. The auditor believed that providers could not establish such plans even though the Tax Code clearly allows it. Because of the recent Tax Court case (see the Speltz case) won by Tom, the Tax Court lawyer quickly allowed the deduction (over $2,400) in this case. Providers who intend to set up a medical reimbursement plan and hire their family members should seek professional tax advice before doing so to make sure they follow all the proper rules.
Many providers deduct 100% of items that can also be used by their family (furniture, supplies, toys, etc.). If you are doing this, you need to be able to prove that your family never uses such items. This is relatively easy for things such as children’s furniture, but can be much more difficult for items such as a rocking chair or CD player. A safer position to take would be to only claim a business deduction of 90% so as to appear more reasonable even though the items may actually be used 100% by the business.
Persistence pays off. I talked with Phyllis numerous times over the phone and urged her to keep fighting because I believed the IRS positions were not supported by the Tax Code. She did everything she could: responded to all requests for information from the IRS, wrote letters, sent copies of Tax Court cases, and talked to the supervisor of the hearing officer when the officer would not look at her records. She then took the next step and appealed her case to Tax Court. She gave me all the records I needed to represent her and after three years she won a significant victory. After her victory, Phyllis wrote to us:
“Tom if it wasn’t for you I would not have been able to fight my fight. I would have had to let the powerful IRS win, even though I knew they were wrong on many issues. I would not have had the resources that you offered me. For me it was not just the money, my integrity was in question and my savvy as a business owner. I have always prided myself with being an honest person and doing the right thing. If it wasn’t for you and your dedication to my cause, I’m afraid I would have given up and not have the satisfaction that I feel knowing that I was just and you helped me prove that. What a boost for my self-confidence!”
This is the fifth Tax Court case involving a family child care provider that I have handled. In all cases the provider saved a substantial amount on her taxes.