Ask Civitas: April 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. If you sent in a question (which you can do on the Ask the Experts page), you should have received an individual response.

What we've noticed is that a lot of these questions have common themes, so we thought it would be helpful for all of you to hear the answers to some of questions that have been sent in. Watch the video below to hear some of the most commonly-asked questions we get!

Can’t watch the video? Here’s a transcript of the questions and answers covered in this video!

Question: I am a sole proprietor with one employee. My Schedule C shows a business loss of about $6,000 for 2022. I have no other income. Would it be better to not take all of the deductions I am entitled to in order to show a small profit for tax purposes? My business is not in jeopardy. I received a PPP loan in 2022. That has been forgiven, and I understand that I do not have to report the PPP loan as income. My business is now stable moving forward.

Answer: This is a great question, and I'm going to give an unsatisfying answer of it depends. It's important to keep in mind, you have to report revenue. You don't have to report deductions. So there are some years where you're going to take a loss. I was talking to a provider just the other day. We were going through her taxes, and she should take a loss. That's what happened. However, you also want to look at the bigger picture. And two things come to mind. One is the IRS does limit a business to three years of losses within five years. So it could be year one, you take a loss, year two, you don't, year three, you do, year four, you do. But then year five, you should have a profit, or they declare you to be a hobby, which means a whole lot of things aren't deductible.

So you want to avoid that. And then the other thing is, if you're a sole proprietor as this reader is, your income is based on what is on line 31 of your Schedule C, your net profit. So in this case, if it's a negative, for things like loans, if you want to get a mortgage or a business loan, it's going to show you it's having no income. So again, if you deserve the loss, if the loss is appropriate and you want to take it, you should feel entitled to. At the same time, you also want to think about what the larger picture might be for your taxes.

Question: I am an S Corp on the books, and I have one employee in addition to myself. I'm being taxed both as an employee and an employer. Is that standard? I'm on the books, so my tax preparer is telling me I need to match my taxes. Is this the correct way?

Answer: Yes. So if you're an S Corporation, you have to have, by law, some form of W2 income, and I'll talk more about that in a minute. And if you are the employer, you're paying the employer side, but you're also paying the employee side because you're the owner. So you should be paying both sides of that, and you should have some W2 income. However, it's really important, if you’re an S Corp, that you do know that you have to pay yourself a reasonable compensation. And what does that mean? That means that the IRS says a portion, and there's a whole long story that we can go into, we won't today, on how you determine reasonable compensation, but that not all of your money has to be taken as W-2 income.

So just easy numbers for me today. If you made a $100,000, and let's say you might take $80,000 in W-2 income, that remaining $20,000 would be treated as ordinary income, which is going to save you time and money because now you're not paying employer or employee side taxes. But that's a story for another day. You can read more about it. We have, and we'll put it in the links, a guide on incorporation. This one happens to be for our client in Texas. It works in all 50 states. So take a look at that, and that'll explain a little bit more of what we're talking about. But yes, you should be getting charged both employer employee in this case. That is standard, and you should have W-2 income.

Question: This one is from someone who is working with a provider. She said, "She told me that the accountant she uses told her that she cannot claim time space percentage because her business is incorporated as an S Corp. I have never heard this before and was hoping you could shed some light on the topic."

Answer: So the accountant in this case is sort of correct. This is two unsatisfying answers, not yes or no. So here's where the accountant is correct. Employees cannot claim business use of the home, right? Right now, at least through 2025, Congress, when they pass the Tax and Job Act of 2017, said, "Nope, we're not doing any of it." So right now, you can't do that as an employee. Now, remember what we just said in answering the last question. If you have an S Corp, you have to be a W-2 employee. You don't have to pay yourself all the money as a W-2 employee, but you have to be one. So if we can't have a home deduction for W-2 employee and you are one, even if it's your business, the accountant's right, you can't do it.

However, there is a very legal way to do it, which is called an accountable plan. An accountable plan is a system used by S Corporations, C Corporations to reimburse employees for business expenses that they incur on behalf of the company. So this can include everything from mileage to other expenses that you do, but also your home. So this becomes a way to do it. It's very simple to set up. We will be soon coming out with an accountable plan guide, but if you Google it, you can find a whole bunch of them. It takes all of about a whopping five minutes to set up an accountable plan. It's not hard, and then you can deduct those things, including her home in that case. So hopefully that will help you out.

Question: I have a question about a basement renovation we did three years ago. I live with my fiancé and our children. My fiancé is the homeowner. I pay for half of the bills. In order to make our basement a childcare space, we had to do renovations to put in egress windows, new drywall, paint, carpet, and other items to make it usable for childcare. Because I do not own the home, my tax preparer would not use those expenses on my taxes. Is that correct or are there ways around that?

Answer: Unfortunately, in this case – see now I can give it a definitive answer – your preparer is correct in this case. So you're not allowed to do this in this case with the fiancé. The way around it would be that you could theoretically pay your fiancé rent or other compensation for the space. The problem is that now he or she would be having to report that income. So that's okay if you want to go that route, but then make sure that they're doing it on their end. We have seen providers where they've said, "I paid my fiancé rent or my boyfriend rent, and so we're all covered, right?" And it's like, "Well, did he declare it?" "No." "Well, then you have a problem because the money went one place and it didn't go back to the IRS." So there you go.

Question: Another tax question! I got about $22,000 as an ARPA grant from the state. I used about $5,000 of that to remodel the bathroom that the daycare kids use. Is that something I can deduct on my income taxes? If so, how do I do that? I do my own taxes.

Answer: In this case, you do need to report the full grant and expenses. So you're going to report the full $22,000 from the state. You're going to deduct appropriately those expenses, right? And we can also put that in the links, but we have a link for how you determine if something has to be depreciated or not. So depending on how you parse out that remodel, maybe you have to depreciate it, maybe you don't. I don't have enough information to let you know that. But if it is something that you could potentially deduct, either this year in total or over a number of years, that would be an option, and you could do that. Do remember time, space, right? So if it's exclusive use, whether it has to be depreciated or not a hundred percent, if it's regular use, you have to apply the time space, and then you start worrying about depreciation.

Question: I am getting all of my windows replaced after one of them was shattered by a daycare child. I am using financing to pay off the job. How do I write off these monthly payments? The total is $11,000 with $200 per month in payments. I do expect to pay it off faster than that, so I'm not sure if that changes anything.

Answer: So here's another case where we're talking about time space issues. And first of all, I hope everyone was okay with the shattered window. That does not sound like it was a fun day at all. So first of all, remember that you could write off a hundred percent of any of those windows that are an exclusive use area. And don't hesitate to ask your contractors to parse those out and say, "Could you give me a separate bill for these rooms versus these rooms?" That's okay. So a hundred percent on those. The regular use areas can be expensed or depreciated, depending on how much they are, check that depreciation guide that we're going to put in the links, using your time and space, right? So again, depending on what that final cost is, you'll see we have a simple flow chart in there. It may be depreciated over time or you may be able to expense it this year. But what's important in what you're hearing is this is all based on the cost and not how much your monthly payments are.

Your monthly payments are not relevant here. It's about how much the cost was overall.

Question: Being a registered family childcare provider, do I need to pay quarterly taxes, or can I pay at the end of each year when I file? I have no employees.

Answer: It really depends on how much you owe in taxes. The IRS said that you should pay estimated taxes quarterly if you expect to owe a thousand dollars or more. And at the end of the year, as you let's say in 2024, prepare your taxes that you had for 2023, the IRS further says that 90% of the taxes you anticipate should have been put into estimated taxes or a hundred percent of 2022, whichever is smaller. So in this case, it really depends on how much you've made, how much you should be putting in. I do recommend you put in something. There's a lot of good calculators out there. If you do your taxes online, they usually provide a suggested estimated tax. It's often a good way to go.

Question:  And is there a penalty if you do not prepay the right amount? How does that work?

Answer: Yes, there is, and it's based on a formula, depending on when the payments were made, how big the payments were. It's not like something unfortunately where I could say, "And it's 2%." But yes, there is a penalty, so there's an incentive to get that money into the Fed. And you do get that money back in a refund, right, if you overpay.

Question: I'm having my taxes prepared and my accountant is not familiar with the stabilization grant money I received. I was told I could use the money for my mortgage, and/or to pay myself, but can either of these be used as a deduction or can I basically just deduct expenses such as supplies, maintenance and all the normal expenses? I do not have as many expense deductions this year, and the amount of money I owe, including the self-employment tax, is quite a large amount. I have put money away for taxes, but never thought it would be so much. Is it worth receiving the grant money if I do not have the expenses to deduct to offset it? It just doesn't seem to make sense to me when I'm trying to understand what the best approach is financially. As for now, it seems like it is not applying monthly for the grant money.

Answer: There's a lot in that question, so let's break down each one of them. So first of all, and this is one of the frustrating aspects of relief funds, what you could spend to comply with the grant doesn't always align with what you can deduct on your taxes. Think of them as two different things. Like a Venn diagram, there's overlap. There's a number of things that they're exactly the same on, but there's also things where they are different. So you do need to make sure that you split those things out, and keep in mind how you comply with one versus the other. In the case of mortgage, yes, you can use stabilization funds for it, but on your taxes, you can only deduct the business portion of your mortgage interest. So you apply time space, but it's only the interest.

So instead of having this whole big piece, you just have this small piece on your taxes. So yeah, that's going to be different. In terms of paying yourself, it's a similar thing, paying yourself perfectly allowable under the stabilization grant. And you can go online and you can see what we've said in the past around how you should do it, but it's allowable. However, unless you're a W-2 employee, like the people in the S corps we were talking about just a few minutes ago, what you're really doing is you're prepaying your profit. So if you're a sole proprietor, you're still under the same tax rules. So at the end of the year, your self-employment tax is based on what's on line 31 of your schedules C, that net profit and loss, and that number is subject to 15.3% self-employment tax. So again, it's one of those things where, can you deduct that if you're a sole proprietor or use it on your stabilization grant? Yes.

However, on your taxes, you still have to pay all the taxes you normally have. The last thing I would say, and I know many of you have heard this over the years from Tom Copeland, years, couple of years since we've had these stabilization grants. He said the same thing about the child and youth adult food care program. I would say the same thing, right? Even if you have to pay self-employment tax at 15.3%, even if you're in the 22% bracket, so you're now paying 37.3%, you're still keeping 62.7%. So I know it's frustrating. I know it's disappointing. I know all of those things. And I'm not trying to poo poo them, but what I would say is 62 cents of every dollar is better than no cents of every dollar.

Question: I am a first year daycare owner. If I hire my children, ages eight and 12, and pay them, will that be considered a deductible expense? And then will they have to file taxes for it?

Answer: So it depends on how much you ultimately pay them. Let's talk about how you do this. First of all, if you hire your children, make sure, we have another guide coming out on that this within the next couple of months, that you are paying them a reasonable amount, that you're documenting their work time, that you're documenting their duties, and that they're reasonable for their age, right? So you can't say, "I left my eight year old in charge of the entire childcare facility." Not allowed. Or maybe it is, maybe you want to try it. I don't think it would be good with your regulator locally, but actually doing it once you meet that criteria. And filing it is not too hard. You're going to want to issue them a W-2, which means you need an EIN, you need an employer number. I know most of you already have them anyway. You got them because when you provide information to parents, you didn't want your social security out there. You could use the same EIN.

All you have to do is... You don't have to do withholding or anything else. You just have to put the gross amount in and you send the W-2 in. You can deduct their wages on your business tax return. And as long as it's under the standard deduction, you can do any one of those simple free ones H&R Block has online, and you could just do the taxes for the eight and 12 year old, just do that using the standard deduction. Now if it's over that standard deduction, then you start getting into a question as to whether they're going to pay the taxes after a certain amount. Now, it has to go back to your tax return. That's where it gets more complicated. But the other day I was dealing with a provider who only paid their kid $8,000, well under the standard deduction, you're good to go, fill out that W-2, only write the $8,000, send it in, and then do their taxes simply and free online.

Question: I recently started a daycare, so I'm trying to stay on top of tracking for the end of the year. We have a driveway that is a half a mile long, and with all of the snow we had this year, we not only used a skid steer, but also a plow truck to move the snow. I believe the time clearing the driveway can be deducted. What about fuel and repairs? Should I be tracking the hours on the skid steer and mileage on the plow truck?

Answer: So there's two questions here really, right? Question is, as we always talk about with transportation, how are you going to do the cost, and how exclusive is it? Right? So let me answer those backwards, right? I probably should said the first one first. One, if anything is used for personal use, including a vehicle, you have to keep track of that mileage. So if you are saying these are a hundred percent exclusively used for the business, it's one thing. If you are using it at times for personal use, which you may be, you're going to want to track that mileage because you're going to have to prorate it in some way. Either you're going to prorate the actual costs based on the mileage, or you're going to be using the mileage reimbursement number.

And that brings us to the second point, which is you can use actual expense or mileage, that's your choice, again, depending on how much you're using it, how old they are, how much it costs take them to operate, would depend on which one of those two options is better for you.

Question: Their driveway is probably very likely shared in their home and their business. It's unlikely that it's a business only driveway. So removing the snow then would be for both automatically? Is that correct?

Answer: It could be. There's a bit of wiggle room here because they can make the case that without the removal, their business, when you talk about the half mile driveway, the business would not be able to operate. Where I start to wonder about the personal versus the business would be if let's say you're closed for a week over the winter holidays and you're still using it to plow every day because you want to get in and out of the home. When you're closed, that operation excuse goes away. So if that's the excuse you were using, gone. So again, in that case, they should be doing mileage now. Do they say the miles going up and down the driveway on a workday when they're normally open is for the business? I would argue yes. But those other miles, not so much, like if it's on the weekend or vacation where it may not be required for their business.

Question: I am writing to ask you if it is possible to deduct a pet that has been bought for the daycare as an emotional support animal.

Answer: I think some days, yes. Depends on how bad the kids are. I'm just kidding. So in this case, I would proceed very cautiously. We've had a couple of these questions lately, which is kind of interesting. They came in a burst, different scenarios, but all very similar. So I did a bunch of research into it. And in some cases, yes, a support animal can be deductible. However, you need to be able to show that it was for therapeutic purposes and documented for therapeutic purposes. So for example, you would need physicians prescriptions written that the children in your care needed this pet as part of their therapy, right? And you would also want to be able to show, if you were audited by the IRS, how it fit into a therapeutic regime for them. So not that... We all know when you pet a dog or cat, it lowers your blood pressure. Unfortunately, that's not good enough. You would actually have to say, "This is how it fits into life Liane's therapeutic regime, and this is how we're using it therapeutically."

Question: I have parents who are divorced. One lives in this state, and the other one lives out of state. One parent is asking for a total of what has been paid this year by both parents. I know I only have to give the parent their total, but one parent is also asking how many meals their child has eaten here at daycare, such as how many days they had breakfast or lunch here. I'm not sure if this is something I can tell them and if I should.

Answer: So there's really two questions here in terms of the amounts, you're under no obligation to share it with either parent. It's a good thing to do maybe, whatever, but you're not obliged to do it by law. So withholding it from one is not an issue. There may be small people political issues with that. So you might be better off not sharing it with either than sharing it with one over the other. In terms of telling them about meals, similar thing, you're not obliged to do that. If they are uncomfortable or concerned, they could always remove their child from care. That's an option. But I definitely get your concerns here, and you don't really have to share either of these.