The Perils of Operating at a Loss
Family child care is a for-profit business. Although some child care providers do earn a reasonable income, many others do not.
In 2007 I surveyed over 500 child care providers for my book on money management. I found that 74% reported a business profit of less than $20,000, and only 5% made a profit of $40,000 or more.
It's not uncommon that some child care providers occasionally show a business loss. What happens in this situation?
There are some limitations of what deductions may be claimed if a child care provider tries to report a loss on her tax return. The house expenses that appear on IRS Form 8829 Expenses for Business Use of Your Home cannot create or increase a business loss. Instead, un-allowed expenses can be carried forward to the next year.
For example, let's say you show $25,000 of income and $20,000 of expenses on Schedule C (before taking into account Form 8829 expenses). Your tentative profit is $5,000. If your house expenses on Form 8829 total $8,000, you will only be able to deduct $5,000 of them (which will create a zero profit) and roll over the other $3,000 of expenses to the next year.
A loss can only occur when your Schedule C expenses (not counting Form 8829 expenses) exceed your business income. Situations where a loss is possible include: low enrollment, a majority of spaces filled by subsidized children for whom you are paid a low rate by the state, and high expenses for items such as food, supplies, toys, repairs, equipment, and depreciation. The loss of even one family can have a significant impact on your income, and many child care providers have lost families because of the current recession.
If you are going to show a loss, you should be aware of how the IRS looks at it. IRS rules say that when you start your business you are presumed to be trying to make a profit. As long as you show a profit three out of the last five years, the IRS will maintain that presumption. If you don’t, the IRS may see your business as a hobby and deny your deductions.
Therefore, if you show losses three out of five years, you will likely attract the attention of the IRS. In my experience, child care providers who show losses in consecutive years are audited frequently. When this happens, the IRS won’t conclude that you have a hobby, but they will be much more likely to disallow many of your business deductions.
My advice is to show a profit at all times, unless you are experiencing unusual circumstances. Showing a loss in your first year or two of business is not something to worry about. It’s also acceptable if you have a major expense one year (car, swing sets or other equipment) that creates a loss.
If it looks like you will show a small loss one year, you may want to consider not claiming some business expenses to show a small profit. If you do show a loss, pay extra attention next year and try to claim a profit by cutting back on expenses.
Whatever you do, don’t go overboard in showing losses, like this child care provider did in California.
The child care provider reported gross income of $321 her first year in business and $7,348 in her second year. But she also claimed $42,600 in expenses her first year and $63,733 her second year! She did everything wrong by claiming a cross-county ski machine, payments to wineries, more than $20,000 for meals, and more. In the end, the Tax Court did allow losses for both years totaling $6,100. This case shows that, although it’s possible to show a loss, you don’t want to go through the agony of an audit unless you have to.
Tom Copeland – www.tomcopelandblog.com
Image credit: https://pixabay.com/illustrations/diagram-crisis-curve-down-loss-5222682/
