Don't Guesstimate Your Deductions

Don't Guesstimate Your Deductions

by Tom Copeland

"How much of the cost of an item can I deduct as a business expense?" is a common question of family child care providers. In general, providers should use their Time-Space Percentage to determine the portion that is deductible for items used by their business as well as their family. Such items include property tax, mortgage interest, furniture and appliances, toys, supplies, and more.

For some shared business and personal items, however, the Time-Space Percentage should not be used. These special items, called "listed property," include a computer, printer, copy machine, fax, television, VCR, cell phone, and vehicle. For these items providers must calculate an actual business use percent, which means determining what percent of each item was used in the business.

A recent Tax Court case (Fabian Vaksman vs. IRS) clarified how to determine this actual business use percent. The case involved a self-employed taxpayer, not a family child care provider, but the ruling applies closely to providers.

The court quoted a portion of the Tax Code that says that no deduction is allowable with respect to any listed property on the "basis of any approximation or the unsupported testimony of the taxpayer... In order to be allowed a deduction with respect to listed property, the taxpayer must substantiate the deduction by adequate records, or by sufficient evidence corroborating the taxpayer's own statement, showing 1) the amount of such expense or other item; 2) the time and place of the use of the property; and 3) the business purpose of the expense or other item."

In other words, a provider can't guesstimate how much of her computer is used for her business. In the Vaksman case, the taxpayer guessed at his actual business use percent and kept no written records to support his claim.

I have represented some providers in IRS audits where the auditors have allowed providers to use their Time-Space Percentage on their cell phone, computer, and television. This new case may change this in the future. Providers who don't have some written records to back up their deductions are at risk in an audit.

How can a provider substantiate her actual business use percent? A provider should save the receipt showing the purchase price of each item. If the item was purchased before the business began and no receipt (or canceled check) is available, take a picture of the item. Record on a calendar or other ledger book the time and place the item is used for business.

For example, the use of computer can be tracked by recording in what room the computer is located, when it is used for the business and personal purposes, and what types of business activities are conducted on it. This tracking should be done for at least two months to show a pattern for the year. If the computer use varies significantly throughout the year, then the business use should be tracked for more than two months. A provider's calendar might show that the computer was used to enter attendance and business expense records each Friday evening from 8-9pm. In addition, the day care children use the computer to play games from 9-11am, Mondays, Wednesdays, and Fridays. That totals eight business hours a week. The provider's personal use of the computer might be four hours a week (as shown on the calendar), for a total of 12 hours a week business and personal use. The actual business use percent in this example is 67% (8/12).

To track the actual business use of a cell phone, include the hours the phone is taken outside when you are with the day care children or on field trips.

The important point to remember is that it is probably not good enough just to guess how much time the computer, television, or cell phone is used for your business. You need to write down when these items are used for at least two months of the year. Following these guidelines may create more record keeping work for you, but if it helps you in an audit and creates more piece of mind, it is worth it.

This handout was produced by Think Small (www.thinksmall.org)

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