Child Care Provider Wins IRS Audit Appeal!
Add another win for a family child care provider after her IRS audit!
Sue Tietz, a family child care provider from Stevens Point, Wisconsin won nearly everything in dispute on her 2009 tax return when an IRS appeals officer issued his report earlier this month. As a result, she owed thousands of dollars less than what the IRS originally wanted her to pay.
Sue’s persistence and willingness to provide the auditors with detailed records made the difference in winning her case. There were many issues in dispute in Sue's audit: an exclusive use room, work hours before the business began, business meals with clients, food expenses, mileage records, and depreciation.
Time-Space Percentage
After the audit began, Sue realized that she had not claimed her day care room as an exclusive use room. Her own children were grown and did not use the room filled with children’s items. The auditor did not understand how a child care provider could claim both an exclusive use room and regular use rooms for her business, until we pointed out the Instructions to Form 8829 Expenses for Business Use of Your Home where this is described. The appeals officer did allow her exclusive use room.
Comment: I’ve advised many providers to successfully assert an exclusive use room at the time of the audit, even though it wasn’t originally claimed on the tax return.
Sue began caring for children in the middle of March 2009. In February and early March she spent 95.75 hours writing and distributing business flyers, re-organizing her office area, cleaning and disinfecting toys, washing walls and carpet and re-arranging her lower level from a bedroom to a day care area. The auditor told Sue she could not count these hours because children were not in her home at the time. We cited a Tax Court case (Uphus and Walker v. IRS Commissioner) where the court said the issue was whether part of the home was used for business, not whether children were present. We won this point on appeal.
The auditor also denied hours Sue spent meal planning (4 hours a week) and time spent on business activities on the Internet (2.5 hours a week). The appeals officer eventually accepted all of these hours.
Comment: Sue had not tracked these hours during 2009, so I asked her to provide the appeals officer with an extremely detailed accounting. (See her January 14, 2012 letter). Many child care providers fail to keep adequate records of the hours they work in their home when children are not present. If Sue had kept contemporaneous records she wouldn’t have had to battle over this issue.
Originally, Sue had claimed a 43% Time-Space Percentage on her tax return. After adding her exclusive use room, and winning all of the above disputed hours, the appeals officer accepted her final Time-Space Percentage of 48%! A five percent increase had a huge effect on reducing Sue’s tax bill.
Comment: Sometimes I hear child care providers tell me that their tax preparer wants to limit their percentage to no more than 30% or 40%. In my experience with IRS audits over many years, there is no upper limit to this percentage, as long as you can show records to support your position. Don’t hesitate to claim all your hours and to claim an exclusive use room!
Meal and Food Expenses
Sue had claimed the cost of meals when she had business lunches at fast food restaurants with some of her clients and her own family members. The discussions at these meals were about her summer program, marketing activities, parent evaluations, child development, etc. The auditor denied the entire $463 expense, but the appeals officer allowed $325 of these expenses, including seven meals with her immediate family.
Comment: Sue claimed 40 meals (a lot), although the amount per meal was small ($11.57). It’s usually risky to claim as many business meals as she did. The fact that she had good records describing the business topics discussed helped her.
Sue had originally claimed $4,583 in food expenses using the actual expenses method. She had $4,300 of food receipts for her business and another $4,900 of food receipts for her own family. The auditor told her she couldn’t use the actual expenses method, but later changed her mind. The auditor also said she couldn’t claim food expenses if her food receipts included any personal food! Sue successfully argued that she spent more on food than the standard meal allowance rates because she was a discriminating shopper and children ate more than one serving at a meal. I asked her to estimate her own average cost per meal and the appeals officer accepted her revised food claim of $2,646 which was $388 more than if she had used the standard meal allowance rate.
Comment: Sue got into trouble with her food expenses because, like most child care providers who use the actual food expenses method, she did not carefully calculate her business deduction. She somewhat arbitrarily identified food receipts as either business or personal, without carefully tracking who ate what food. The best way to calculate food expenses using the actual food expenses method is to estimate an average cost per meal using receipts.
Mileage
Sue claimed 2,111 business miles, and the auditor allowed only 774 miles. To prove her claim, I asked Sue to go back through all her receipts and check register and identify her business as well as personal trips. She made 158 business trips and another 124 personal trips to the same destinations. The appeals officer accepted all her business miles.
Comment: Auditors sometimes will challenge business miles if the child care provider buys both business and personal items on one trip. They usually won’t accept 24 business trips to Target if the provider made a total of only 24 trips to Target. It’s always a good idea to keep a record of personal trips to the same destinations. This will help prove that the business trips were business.
Depreciation
Sue purchased a $1,577 carpet in 2009 and depreciated it over 7 years. But, once she realized she had an exclusive use room and that the carpet was installed in this room, she asked the auditor to apply the Section 179 rule. This rule allows taxpayers to deduct the entire portion of items used more than 50% for her business. Although the appeals officer accepted her exclusive use room, he did not apply the Section 179 rule because he looked at her 48% Time-Space Percentage and concluded she used the carpet less than 50% for her business.
Comment: This was clearly the case of the appeals officer not paying attention to the fact that the carpet in the exclusive use room is used 100% for business. Although Sue could have brought this up after reading his report, we decided it wasn’t worth fighting over, since she won on most major issues. In the end, she will eventually get this full deduction because she will be depreciating it in later years.
Other
The original auditor charged Sue penalties for failing to file an accurate tax return. All of these were dropped by the appeals officer. Sue also claimed one of her children as a dependent while she attended school. However, the child did not meet the definition of a part-time student, so she lost this deduction.
Notes on this Case
Sue contacted me in early 2011 for help. At the initial meeting the auditor asked Sue for documentation of bank deposits and business deductions. This is a common outcome of early meetings with auditors. Initially the IRS often looks for signs of any unreported income and Sue provided bank deposit slips and other records to show that a series bank deposits were not day care income and thus not taxable income.
But, despite having received numerous records and documents from Sue supporting her claims, the auditor issued her final report in May 2011 denying thousands dollars of her business deductions. Because the auditor’s report did not treat Sue fairly, I urged her to appeal her case. Appealing an auditor’s report costs nothing.
Five months later (November 2011) the appeals officer contacted Sue and they met in January 2012. Sue submitted a series of letters with my help to back up her positions. The final report from the appeals officer came in early April 2012.
After Sue received the auditor’s report I urged her to request a copy of the original auditor’s notes and reports to the appeals officer. This information is available to taxpayers who appeal their cases. Sometimes information in these reports can help in the appeal. In Sue’s case, the original auditor wrote in her report, “[Sue] has been difficult to work with throughout the audit.” The auditor also claimed that Sue cited a tax law incorrectly, but this proved to be wrong as Sue’s position was upheld on appeal. It’s been my experience that sometimes IRS auditors react unfavorably when child care providers don’t accept their initial findings. Sue was very surprised at the comment that she was difficult to work with. The auditor demanded a lot of records and Sue worked hard to produce them. It’s also interesting to note that the auditor was convinced of her interpretation of the tax law that proved to be wrong. Unfortunately, it took going to appeals to get Sue’s position accepted.
Tom Copeland - www.tomcopelandblog.comImage credit: https://www.picpedia.org/highway-signs/v/victory.html
