Lessons From an IRS Audit

If you don't understand the unique tax issues affecting your family child care business, you may not get any help from your tax preparer and even the IRS!

A family child care provider who is now being audited by the IRS is finding this out and faces a $10,000 tax bill.

When a family child care provider hires a tax preparer, she expects that person to understand her business and file an accurate tax return on her behalf.

If she gets audited, she expects the IRS auditor to understand her business. And, if she hires a new tax preparer to defend her in the audit, she expects the new tax preparer to understand her business.

Here's what happened when her two tax preparers and the IRS auditor didn't fully understand all of the unique tax issues affecting family child care providers.

This week a family child care provider emailed me for help regarding her IRS audit. Later in the week I spoke with the tax preparer who is defending her in the IRS audit.

I was able to identify five areas that her two tax professionals and the IRS auditor had missed. They involved issues that will help significantly reduce the amount the provider will owe the IRS.

Issues

Exclusive use rooms: This provider had a basement area used exclusively for her business, but her tax preparer only counted it as space used regularly. This resulted in a much lower Time-Space Percentage than it should have been.

Family child care providers are entitled to count rooms used exclusively for their business as well as rooms used regularly for their business. See the Instructions to IRS Form 8829 Expenses for Business Use of Your Home, page 2 under the heading, "Special Computation for Certain Daycare Facilities." It describes how to calculate your Time-Space Percentage if you have both exclusive use rooms and regular use rooms. This provider will be able to significantly increase her Time-Space Percentage because of her exclusive use space.

Garage: This provider had not included her garage in the total square feet of her home nor counted it as regular use space for her business. The IRS Child Care Provider Audit Technique Guide clearly states that garages (even if detached from the home) must be counted as part of the home. Because this provider uses her garage to store day care items as well as household items (garbage can, yard tools, etc.) she is entitled to count this as regular use space. Since she had several rooms in her home that were not used regularly for her business, adding the garage will increase her Time-Space Percentage.

Car loan interest: Many providers are not aware that they can deduct the business portion of their car loan interest, even if they are using the standard mileage rate to claim expenses associated with their car. See IRS Publication 463 Travel, Entertainment and Gift and Car Expenses, page 16. Her tax preparers and the IRS missed this deduction.

Depreciation of property owned before the business began: Most providers do not realize that they can depreciate their furniture, appliances and many other household items that they owned before their business began. If they haven't done this, they can go back and recapture all previously unclaimed depreciation on their current tax return, using IRS Form 3115. See the IRS Child Care Provider Audit Technique Guide for further information.

Hours worked when children are not present: Most providers work a lot of hours before and after children are in their home on business activities such as cleaning, activity preparation, meal preparation, time on the Internet, record keeping, etc. Few providers keep accurate record of these hours that can increase their Time-Space Percentage. That is the case with this provider who is being audited. I gave her some advice about how she can try to reconstruct her records to make a case for the time she did work, but didn't claim.

One other issue

This provider's original tax preparer made a mistake in not reporting as income the reimbursements she received from the Food Program. Money received from the Food Program is taxable income. When you deduct food expenses you can count the meals and snacks reimbursed by the Food Program.

Lessons

Tax preparers and the IRS should understand these unique issues affecting your business. But, as we see, they don't always do so.Therefore, it's important for all providers to take a little time to learn these unique rules and bring them up to their tax preparer if necessary.

I've made this easier for providers by including these issues, and many more, in my annual Family Child Care Tax Companion. This book is designed for providers who use tax preparers. If you share it with your tax preparer it can help you reduce mistakes and ensure that you pay no more tax than you should.

Tom Copeland - www.tomcopelandblog.com

Image credit: https://en.wikipedia.org/wiki/IRS_penalties