How Low Can You Go? Why You Might Want to Show More of a Profit on Your Tax Return
We always try to help child care businesses get as much money as they can. One of the best ways to do that is by minimizing the taxes that you pay each year – fairly, of course.
For home-based providers who are sole proprietors, this means having the lowest number possible on Line 31 of your Schedule C – the place where you show your net profit for the year. Your net profit is the revenue that you took in less all of your expenses, including those that pertain to your home. The amount listed on Line 31 is taxed as self-employment income at a rate of 15.3%, which is why minimizing that figure can save you money.
But there may be a time when you might want that number – your profit – to be higher than it might have to be. Why? The most common reason is if you are applying or plan to apply for a mortgage or a refinance. Rightly or wrongly, the mortgage industry looks at Line 31 as being your income, just like they would an individual's paystub if they were a W2 employee.
This has frustrated many home-based providers who have done a great job of minimizing their profit on Line 31, only to apply for a mortgage and be told they don’t have enough income – especially without a co-signer on the loan.
Typically, mortgage lenders look at your last two years of Schedule C income (though they can look at more if they so choose) and average them. That means they'll add up year one and year two, divide it by two, and take the result as your average income.
For example, say you showed a net profit on Line 31 of $16,000 in 2020 and $21,000 in 2021, the average income would be $18,500.
$16,000 + $21,000 = $37,000
$37,000 / 2 = $18,500.
Accordingly, as you start to think about applying for a mortgage or refinancing your current mortgage, you may want to talk with your tax professional about potentially increasing your Line 31 during that period. That could mean forgoing some possible deductions, but the end result could be worth it.
Taking a Look at Your Expenses
In addition to the possibility of increasing the amount shown on Line 31, Tom Copeland, a long-time expert in the field of child care, has also shared some strategies that may help child care providers present a more accurate depiction of their ability to pay back a loan. Tom stated that there are a number of expenses on your Schedule C that do not represent the payments made in that tax year.
The first type of expense that is not exclusive to that tax year is depreciation. As you depreciate items the cost is reflected in a business deduction taken over a number of years. The amount of depreciation expenses that are shown on your Schedule C do not represent any actual expense you had for that year. The depreciation of these assets is shown on line 13 of the Schedule C. When applying for a loan your profit for that tax year is best represented with line 13 subtracted from your expenses.
Other expenses that can be addressed as not accurately representing the amount shown on line 31 are expenses found on Form 8829 (Expenses for Business Use of Your Home). House depreciation, found on Form 8829, Line 41, represents expenses that exist even when you are not in business and should not be included on Schedule C, as they are not paid out of your business income. The business portion of your house expenses, shown on Schedule C, line 30, should also be removed from Schedule C.
It is possible that your bank may not accept a revised Schedule C. At that point, you can prepare a monthly cash flow statement to show the sources of monthly income and the amount of monthly expenses. We have a cash flow workbook template you can use, and you can also find a cash flow statement template in Tom Copeland’s book Family Child Care Business Planning Guide. Bank officers may accept a cash flow statement if you are able to explain why this is a better reflection of your ability to pay back a loan than is reflected in your Schedule C.
It is important to remember that one bank denying your loan is not an indication that you will not be able to get a loan. A credit union or neighborhood bank may be more receptive to issuing a loan than would a large bank. It is important, however, to be aware of predatory loan practices. You should make sure that the interest rate and the terms of your loan are reasonable and do not put you at risk. Research interest rates that correspond to your credit rating and the amount of assets you possess and share the loan documents with a lawyer if you are concerned about, or do not understand, the terms and conditions.
Alison LaRocca is Vice President at Civitas Strategies and President & CEO of Luminary Evaluation Group. Prior to joining Civitas Strategies, Alison was an educator at the Community Day Charter School in Lawrence, MA. She has also consulted with multiple schools on using performance data to improve student progress and crafting new, cost-effective learning tools and techniques that continue to be used today.
Photo by Karolina Grabowska
