Ask Civitas: June Reader Questions Answered!

You have questions, we have answers! Since taking over Tom Copeland’s blog last year, we’ve heard from a lot of you who have questions about the business of family child care. Here’s a roundup of the latest questions we’ve received from all of you, via the Ask the Experts page.

Can’t watch the video? Here’s a transcript:

Question: My husband and I have been dreaming of beginning an in-home daycare next summer. We have begun purchasing things we will need and are finishing an extra bedroom and bathroom in our basement. Are these things we can deduct from our taxes in the future? We haven't begun serving children yet and I am working towards my license but wasn't planning on having that finished until next spring. Do I need to get my license sooner to be able to put the construction and daycare material expenses on our taxes in the future.

Answer: First of all, congratulations for taking the first step towards starting a new business. That's an awesome thing. I think small business in general is a wonderful thing and especially when you can serve children. Congratulations on that. This is what's interesting around startup costs. There's a lot of people, including a lot of accountants, who misunderstand it. And what they'll tell you is it's a year before or it's six months before. A year is pretty typical, you'll hear.

The actual IRS regulations are a lot more forgiving. And what they say is from the moment that you commit to start the specific business. In other words, it isn't just maybe I'll open a childcare business. Let me learn a little bit more about the industry. That doesn't count. But when you and your husband have where you say we are committed to do this, from that moment onward, things are deductible. Whether it takes a year, two years, or eight years.

Now the point where you could deduct them is when one of two things happens. Either you start the business. So, let's say you don't start it until spring of 2024, the things that you're spending on now would not become deductible till spring of 2024.

That's when you'd report them. And you'd report them as startup costs in your taxes. There's a special place for that. Right? Or you decide definitively we are not going to pursue this business. Period, full stop. And that's it.

The two things I would just keep in mind is do remember you still are subject to all the other tax implications. So, as you're working on the bedroom and bathroom, look at the information on depreciation, for example. The other thing is that the IRS allows you to have up to $5,000 in startup costs upfront. After that, and there's a complicated formula, you are allowed to still take the costs after that.

So, if you have $20,000 of startup costs, and again, a lot of CPAs will say, "Oh, you can only have up to $5,000," that's actually not true. You can have $5,000 that you can deduct in the given year. If you have more than that, there's a complicated formula which lets you amortize it, which essentially means that you get the deduction over a number of years, but you still get the deduction.

That's where it gets a little complicated. I won't go into the formula today. But yes, go ahead, start keeping those receipts, start keeping the records of those expenses. And when you do get to that point where you start up, you got startup costs to report.

Question: If I run an in-home daycare and have to close to take a leave to care for my spouse who was diagnosed with a grade four glioblastoma, am I eligible for unemployment benefits? We have three children of our own. So, obviously this is a sad situation and we send you our condolences.

Answer: Just a horrible situation. And I wish I could offer some guidance that was definitive to help you. And unfortunately, this depends a great deal on your state. Very typically, unemployment benefits are not afforded to people who are self-employed. I'm assuming you're a sole proprietor. You may have a S corporation or an LLC as an S corporation, which is a different situation. But it does depend on your state.

The other thing is that many states, or some states, not many, also have medical leave that's open to the self-employed like we do here in Massachusetts, for example. So, that may also be an option depending on your state. So, what I would say is start by checking in with your state unemployment division. Give them a call, explain the situation, and then start on your path there, and best of luck with it.

Question: I am a large family childcare provider. This summer our enrollment numbers are dropping. I have one employee. If I cannot fill those spots, I may need to have her draw unemployment. How would this affect me and my quarterly unemployment payment? How much can I expect it to go up?

Answer: See, this is another where I can only give you a fuzzy answer. Because it depends on a lot of things. It depends on your frequency of layoff. For example, is this the first time, is this something where it's seasonal that you've in the past had issues where over the summer they drop enough? And some providers do that.

I know there are some providers, there are many providers who over the summer when things drop, they lay people off. And then like seasonal employment, they bring them back in the fall. So, that affects it. The duration. Right? How long exactly is she going to be laid off? Is it three weeks or is it three months?

And of course, each state has its own policies. Just as we were talking with the previous call and question about how unemployment is addressed. So again, this is another one where I'd say start by contacting your state unemployment division, get some information from them, and then see where you go from there.

Question: Our next question has some local lingo in it that I had to look up, so I will explain that to you. So, here's the question. I own a two-flat. So, a two-flat, I had to use my friend Google, and I found out it is a Chicago building with two apartments on two separate floors. And the person who sent this in was from Illinois.

So, the first floor is used just for daycare and all of it. So, all of the second floor is where I eat and sleep. My accountant is telling me that I can only use it as shared home space. If my gas, electric, and water bills are only for daycare and the square footage is only daycare, can I use 100% of those bills, or can I add the footage of my space and the bills of my house together with the daycare?

Answer: It's a great question, and it's one that comes up a lot. We do entire webinars on time/space. I'm not going to kill anyone with the ins and out of time space, but this is why it's so critical to know how time/space works and how it affects your taxes. So, just at a high level, there's two types of space in your home. There is exclusive... or really three, I should say. There's exclusive use, and that means that it's only used for childcare.

So for example, and these are real world examples, we had a provider in Texas who had... the basement was entirely set up for the kids. There's a separate entrance from the backyard into it. Right? Once in a while, do people go down there for personal reasons? Yes, once in a long while. But 99% of the time the kids.

We had another provider who set up her son's former room, he had moved out, and made it into a nursery for some babies that she had. Again, exclusive use. Right? Do people maybe wander in there, her friends, her family? Yes. But it has cribs, it is set up as a nursery. Right? Exclusive use.

Regular use, and I should say the third bucket, is it doesn't get used at all. For example, a lot of people don't let the kids in their primary bedroom. You can't include that. But regular use means that you're using it on a regular basis. So, in some way it's shared both personally, but also with the business. And that could be space that they're in like your living room. That could be space the kids aren't in but is used for your business.

For example, we had one provider who does not let the kids in our kitchen, but does use it on Sundays to do all her meal prep for the week. That's regular use. So, depending on if it's exclusive use, the costs in that exclusive use area are 100% deductible.

There's a caveat I'll get to in a minute. Regular use always uses time space. The caveat is anything that's shared across your home uses that time space as well, so your utilities like your electric and those sorts of things. So, unless you have a separate meter that you could say this is only in the exclusive use area, it doesn't work. You would have to use time space.

And the other thing I would say is just remember, because this comes up a lot in situations like this, even if the first floor is used almost entirely for childcare, if that's your main entrance to get to the second floor, it is considered regular use. In fact, we had a reader not too long ago who is under audit and is going to be under audit for previous years because she said, "Well, we just walked through it," and the IRS said, "That's regular use." So, just want to warn everyone on that one as well.

Question: I have a parent speaking about me on Facebook, and I'm wondering what I can do about it. I'm assuming this parent is speaking negatively about the provider.

Answer:  Yeah. And I feel like there's so many of these questions today that I don't have great answers to. This is one where there's really not too much you can do about it. It is very hard to... And I know this is painful, this is frustrating because you're probably sitting there saying that these things aren't true.

Really the only recourse you would have would be to sue her. And to sue her, you would have to be able to show, and prove in court, that it was clearly damaging your business. So, you'd have to probably have some affidavits from some parents who said, "Oh, we saw this person's Facebook post and we decided to pull our kids," and all these other things. So, that's really unfortunately the only recourse.

If that is something where you say I do feel like we have evidence that she has damaged my business financially or otherwise, I mean, really it does have to come back to some way financial, even if it's reputational, you would really need to engage an attorney.

And I'd strongly encourage you to do that before you take action because the last thing you want to do is spin something out of control where you then say some things back over social media, and now it's a much crazier situation. So, if you really do feel like it's something you want to pursue, start by talking to an attorney.

Question: I am a family childcare educator, and I'm trying to figure up if I should maintain my status as a sole proprietor or move to an LLC. I know there are tax changes that may benefit me, but is that enough to make it worth it?

Answer: It depends on so many factors. I think that there are certain... So, first of all, if you're a sole proprietor, that's a type of business. An LLC is a construct of the state. And you actually have to say to the federal government how you want to be taxed. And you can be taxed as any sort of a federal corporation.

So, they're not really comparable. It's a little bit of apples and oranges. There can be some advantages of moving to an LLC, a variety of different advantages. There could be some disadvantages. And again, this is something we do entire webinars in this topic because it's lengthy.

What we can do is we can post a guide that we have from our work in Texas. It's free. You take a look at it. There's an accompanying video that might give you some guidance on it. But it'll at least give you a window into this larger question and what you need to be thinking about.

Question: Our next two questions are both about swimming pools. Maybe it's the start of summer, so people are thinking about swimming pools. But here we go. First one, we are getting our taxes prepared and have a disagreement in business deductions between us and the tax preparer. Last year we received a loan to have an in-ground pool installed. It was installed in September, and we began making monthly installment payments in October. We also had to pay 10% down on the loan in the spring of 2022.

We have two questions about this. First, our tax preparer said we have to calculate a new time space percentage for the pool. Do we need to do this? Second, they said the monthly installment payments are not business deductions because it is borrowed money. Do we get to claim the principal and interest of the monthly payments for the pool like we do for a mortgage? A mortgage is borrowed money, too.

Answer: Great question. And one that certainly, as you said, Liane, is coming up with summer. Similar ones come up around other types of business loans that are mixed business personal. So, I'll talk about those as well.

So, first of all, let's answer the question around time/space. Yes, you need to do your time/space calculation every year because it needs to match. And your taxes, what you're reporting for that given year is your time space.

That is sometimes frustrating to people because if they have a year where for whatever reason they were closed more or something along those lines, it could mean that number goes down this year and then returns higher. And they go, "Well, gosh, that seems unfair because normally it would be high." Unfortunately, that's the way the tax law is written. So, that's number one.

Number two, can you claim the monthly payments? You cannot, but you can claim the interest. And by the way, that's the same as your mortgage. So, I just want to make sure if you have other business loans that are shared personal business like your mortgage, maybe a car that you have a loan on that you're also reporting the actual costs again, you cannot charge that principle to your business, not through time space, not through any reason.

And the rationale is because essentially the IRS is saying that's already your money. Right? That if I take a $10,000 loan, that money has come to me, the IRS is not charging me for that money as income because it's essentially future income. And then when I pay it back, well, the income I had to pay it back has been taxed and I'm paying myself back essentially because I have the asset.

But what the IRS does say is you can claim the interest because that's a new expense. Right? That's something that you don't get anything out of. You're not paying yourself back on interest. Right? That's going to the party who has lent you this money. So, that is true of the pool, that's true of your mortgage, that's true of your car. So, your accountant in this case or your tax preparer is correct that it would just be the interest.

Question: In regard to the time space around the pool, it's just they're not calculating a new time space just because they have a pool. It's something that has to be done every year regardless of whether you make a big change to your property like that?

Answer: That's 100% correct. It’s the time space is the space that you're using for that given tax year. So, it's calculated when you're preparing your taxes. So, when you do 2023, you'll have a new calculation. Now for some providers that calculation is the same as 2022 and 2021 because they had roughly the same hours and used the same space. That's okay. But it should be something you look at with fresh eyes every year in case there are variations to it, and you do have to do that.

Question: Would a childcare provider be able to deduct their new swimming pool as a business expense? The pool is used by both the daycare children and the homeowners outside of daycare hours. And if they can deduct it, does the time space percentage based on their home automatically apply to the swimming pool?

Answer: So again, what we'd be looking at is time space. Right? So, can you deduct it? You can. You would use your time space and it would apply to your pool.

The one thing I would say is do carefully document that you are using the pool as part of your regular operations. So, maybe that is keeping a log of when the pool is being used. Right? Maybe it's every day from 10:00 to noon the kids go out in the pool, weather permitting. Having some sort of documentation that says how you're using it.

And the only reason why I say that is because it is allowable, but it is something that is not necessarily typical. And so, if you were audited, you would want to have something that said before I had the audit, I did document that we're using it regularly as part of our operations, and it's not just a one-time thing where it was a hot day and I let the kids in.

Question: Another question about deductions. Tax season may be over, but tax questions are year round here. So, if we have to board our dogs in order to go to a conference, can we deduct the cost of boarding?

Answer: So, in this case, unfortunately, it is likely you cannot. And I say likely because, as you can imagine, this is not specifically addressed by the IRS, but taking a close look at the guidance that is out there, I would not see how it would be deductible. So, can I tell you definitively? No, I can't. But I would say you're really taking a big chance if you do.

Question: We did an interview with parents who seemed a bit problematic. Do we have to offer their baby a spot, and how do we tell them that we don't think our daycare will work out for their child?

Answer:  So, what I would say is, so theoretically can you tell them that it's not going to work out? Yes, but I would tread very carefully with this. The Civil Rights Act of 1964, which was a huge sea change for our country in a really positive way, did include that you cannot refuse service because of national origin, gender, religion, color, race.

And so, I'm sure that this is not a factor for you. I don't want to make it sound like I'm accusing you of anything. I'm not. But what I would say is knowing that those could be a problem, and maybe it's nothing that would ever be applicable in this case. There's something very specific that you have a concern about that is totally unrelated.

I would say if you do proceed, carefully, very carefully document your rationale, even if it's like a memo to yourself in a file. Right? Explain to yourself if you were ever... you did end up needing it for legal action, that you had the clear, clear, clear rationale as to why not this person and why somebody else who may be different based on those characteristics. Right?

And I would very carefully word that rejection to your parents if you do proceed that way so that they can understand why it's them versus other parents. And write it as if you're going to be in court. And I'm not trying to freak you out. I just think a lot of times when we write things, we do it as a quick text or something because we want to get it done. And texts, for example, can be subpoenaed and used in court.

So, think about the wording. Think about if this was read in court, how would it sound? How might it be misconstrued, which is more importantly. So, can you do it? You can. I would just be very cautious.

Question: I was told by my CPA that I couldn't claim both the miles on my commercial daycare bus and the repairs on it. My bus is used only for daycare. Can I claim both?

Answer: Your CPA is correct in this case. You can't claim both. So, the general rule is you can claim mileage or you can use the actual cost method. And the actual cost method, you could deduct everything like your gas, any maintenance to it, depreciation, all of those things. But with that actual cost method, you also have to have documentation for all of those things. You have to keep those gas receipts and other things.

So, you get one or the other. Unfortunately, you can't say I'm going to do mileage because it's easier most of the time, but then when it's an extraordinary thing, I'll charge them. I'll charge it as a deduction. So, one or the other.

Question: The next two questions are about hiring family members, which is a common topic. First question, I'm thinking about hiring my seven-year-old stepson to work in my home childcare program when he visits his dad, who is my husband, during the summer months. I am the stepmother but have not adopted him. How can I do this and claim him as an employee?

Answer: The only way that you could do this, and I'll explain why in a moment, would be to hire the child as you would any other employee. And so, what that means is, number one, your state may not allow it. Right?

So, for example, in the Commonwealth of Massachusetts, you cannot hire a seven-year-old unless it's extraordinary circumstances, and you would need to document those, and likely this would not fit. Right? So, number one is if you're going to do it, make sure that your laws, your state laws not knowing what state you're in, allow it.

But you would also have to pay all the taxes just like any other employee, to which probably some of you're saying, "Wait a minute, Gary, I know that there are a lot of taxes I don't have to pay when I employ my child." Unfortunately, the way the guidance is written is that it does need to be your child either adoptive or natural."

And I am not disparaging anything. I mean, you're probably a wonderful stepmom, but unfortunately it comes back to what is, what's the federal law? And the law is it wouldn't work as your child in terms of those tax breaks. So, can you do it? Maybe. It depends on your state law. If you do it, do anticipate that it would be treated... he would be treated as any other employee.

Question: All right. Okay, so similar question from another provider. I know that we are allowed to hire our minor children in our business. Does it have to go through my payroll service, which I use to pay another assistant, or should I just keep records of payments made to that child?

Answer: Great question. And again, as I was just saying, you can hire your minor child, you can do that. There are some tax breaks to it. You should keep definitely, and I want to make sure we say this before we get to the tax implications, records of their work, their pay. Any employee agreements you have they should be filling out just like you would any other employee.

If your minor child is at a point where they can't easily fill that out for themselves, then have your spouse do it if you can or somebody else who has authority to sign for them so it doesn't just you signing it. Worst case you can. But definitely have some recordation that you are engaging them. And if you were ever audited, you'd be able to say more than just, "Well, he was on the books." Right?

In terms of a payroll service, I mean, it really depends on your level of financial acumen and how courageous you feel. So, some people just like to hit the easy button. They like to use a payroll service because you do have to issue a W2 at the end of the year and you are going to have to file taxes for them. Even if it's below the standard deduction, technically you should be giving them a W2, and they should be showing that they filed taxes even if they had no taxes due.

But do you need a payroll service for that? Again, depends on your level of courage. A lot of people may want to hit the easy button and do it. Others may say, "Well, if I just have to fill out a W2 that gives the amount of money that he or she made in a year and no other tax information, gosh, I can do that."

So, what I would say is talk to your tax advisor about it, find out which one you're comfortable with. Also, if you are incorporated, it's different. So again, that's another conversation with your tax advisor if you have a corporation.

Question: We are down to our last question, which we touched on a little bit earlier in a related question, but here we go. If monthly rental payments can be deducted from taxes using time space, why can't my mortgage payments? I know mortgage interest is deductible, but why not the actual payments?

Answer: This is one, as we mentioned earlier, that could be really confusing because it feels like it's a payment, this is another payment, what's the difference? And of course, the difference is if I pay a thousand dollars in mortgage, that money's gone. I don't have any equity. I don't own the apartment, I don't own the condo, I don't own these things. That money just goes away.

If I have a mortgage, I'm building an asset. I can sell my house. Right? And will I get the same amount as I put into my mortgage? Likely you're going to get more because houses tend over time to appreciate. I know there are certain circumstances where they don't, but in general they appreciate. But essentially you're paying yourself back. These are funds that the bank is giving you against your future income. And then when you pay them back, it's like now I have the cash.

So, it's considered to be your own asset already. You don't have to report when you get the loan, by the way. You don't report the loan payments. The interest, again, is an additional payment to that lender that you never get back and you don't see any benefit from other than, of course, being able to access the money when you want it versus having to wait until you've earned it all.

So, that is deductible as any other business expense. And again, that goes for any other business related loan, car. Your EIDL loan, some of you have an EIDL, same thing. The EIDL principle is not deductible, but the interest is.

Thanks for all of your questions. We will be back next month with more answers for you, so keep sending your questions in!