Questions and Answers

Questions Tom Has Answered

These are questions that Tom Copeland has answered by phone or email. We've reproduced them on our Web site because we believe that they represent issues that are particularly important to family child care providers: 

Can I claim the miles I drive to the grocery store as a business trip?

You can claim business miles for all trips in which the primary purpose was business. If you are buying more business food than personal food, this is evidence that the trip was primarily for your business. Don't try to claim all trips to the grocery store as business because the IRS will assume that some of these trips are personal.

I have recently joined the Food Program. My first reimbursement check won't come until January 2007. How do I handle this on taxes?

You report income when you receive it and expenses when you pay them. Report the January check (for December meals) as income in 2007. Similarly, if you make a business long distance call in December, but don't pay the utility bill until January, report this as an expense for 2007. For credit cards, claim the expense in the month you made the purchase, because you have committed yourself to the payment when you sign the credit card slip.

Is money received from the Food Program taxable, and if so, where should it be reported on the tax forms?

Money received from the Food Program for day care children is always taxable. Money received for a provider's own children is not taxable because it is considered a "benefit" under the Food Program regulations. Taxable reimbursements should be reported on line 6 Other Income, Schedule C.

How do I handle the taxes if I am currently an un-registered day care provider?

If you are legally exempt from licensing or registration in your state then you are entitled to claim the same deductions as a registered or licensed provider. In other words you can claim all direct expenses (food, toys, car mileage, etc.) as well as a portion of your house expenses (house insurance, utilities, property tax, mortgage interest, house repairs, and house depreciation). If you are operating illegally under your state laws, then you cannot deduct any house expenses for your business For details, see my booklet, "Caring for Children in Your Home" on our website.

What's the biggest mistake providers make when they start their business?

Probably failing to save all the records and receipts they should. Saving food receipts and tracking hours worked in the home (including hours doing cleaning, activity preparation, meal preparation, parent interviews, etc.) are the two most important record keeping rules to follow as you begin your business.

I did child care in my home for several years before I was licensed. I didn't claim any house expenses for those years. Did I miss out and, if so, what can I do about it now?

You can claim house expenses (property taxes, mortgage interest, utilities, house insurance, house repairs, and house depreciation) as long as you are licensed, certified, or exempt from regulation. Assuming you were exempt from licensing, you can go back three years and file an amended tax return (Form 1040X) and claim these deductions. You will get a refund plus interest.

What records do I need to keep to claim food expenses on my tax return?

Under the Standard Meal Allowance rule passed in 2003, providers can now use a standard meal allowance rate without having to save food receipts. Keep track of attendance records and meal counts.

My tax preparer says I can't depreciate any of my furniture and appliances that I owned before my business began. Is this true?

You are entitled to depreciate all of the property you use in your business, even what you purchased before you went into business. You would base the depreciation on the lower amount of the value of the furniture and appliances as of the time you started using them in your business or the original cost of the item. If you have been in business for several years and have not depreciated such items, you can go back and recapture all previously unclaimed depreciation by filing Form 3115.

This year we leased a new van instead of purchasing one. How do I claim business deductions for the van?

You have a choice. You can use the standard mileage rate or you can use the actual expenses method. The actual expenses method allows you to claim the business portion of the lease payment, plus gas and any other expense to operate the vehicle.

If I was supposed to be paid and never was, can I count this as a bad debt and claim a business deduction? A parent left owing me $1,000.00.

No. Money you didn't receive cannot be deducted as a loss or bad debt. It just means that your income is $1,000 less than what it should have been and you report less income and therefore pay less in taxes.

Can I claim part of my water and cable TV bill as an expense?

Yes. The tax court case Simpson vs. Commissioner clearly allows providers to claim these expenses. Use your Time-Space percentage to determine how much of these expenses are deductible.

We are remodeling our basement for my day care. My husband is doing most of the work. Is his time deductible?

Only your out-of-pocket costs of remodeling work on your home can be partly claimed as a business expense. If you paid your husband to do the work, then you would have to withhold social security taxes and he would have to pay taxes on the income. Some of the time your husband spends could be counted in your calculation of your Time-Space percentage. If the remodeled room is used exclusively for your business, you can depreciate 100% of the cost of the work. If the room is used partly for personal purposes, then depreciate the Time-Space percentage of the cost. Depreciation of a home improvement must be claimed over 39 years.

Occasionally I care for a child in the neighborhood without charging the parent for my time. Can I deduct the cost of the food I serve this child?

You cannot deduct costs associated with the care of a child unless the child is part of your business. In general, by not charging for the care of this child you are not treating the child as part of your business operation and therefore could not deduct the cost of the food served to the child or any other expenses for this child. If, however, you have a business relationship with the child’s family you may be able to deduct costs associated with this child. You could show a business relationship if the parents of the child previously paid you and you were offering free care until the parents got back on their financial feet. You could also show a business relationship if you occasionally offered free care in your neighborhood to low-income families as part of the mission of your business. Such community activities could be deducted as advertising costs if you advertised this service to potential clients. Some providers do not feel comfortable counting such free care as a business expense because they don’t associate this with their business. If you are not thinking about your business when you provide free care, then don’t claim expenses associated with it.

My wife and I care for children until 3 or 4am. In your opinion, is a 54% time usage of one's home excessive from the IRS point of view?

Claim all of the hours that you work. The longer you work, the more carefully you should keep records showing exactly when each child was present. Although a 54% Time-Space percentage may draw more attention from the IRS than a 30% Time-Space percentage, you are entitled to claim these hours. Not to claim them would be giving up. Don't worry about whether or not you may be audited. Just focus on keeping accurate records.

Some of the providers in our group are working on our CDA (Child Development Associate) by correspondence in our homes. We are also spending time writing contracts and policies. Can we count these hours in calculating our Time-Space percentage?

Yes, you can count all hours spent working in your home on business activities such as CDA paperwork, writing and revising contracts and policies and any other activity that you wouldn't otherwise be doing except for your business.

Can I count any of my basement space in my Time-Space percentage, even though my child care children do not go down there?

You can count any room that is regularly used for your business in calculating your Time-Space percentage. This includes any rooms that you are using for your business, such as a storage room, laundry room, or furnace area. Children do not have to be in the room for it to be considered regularly used for your business.

My husband will be retiring in a few years. Our plan is that he will help with my daycare. If I pay him, I will also have to pay Social Security tax for him, right? Can I not pay him and put that money into an IRA for myself (I am 10 years younger) and then that will lower my taxable income? Or is it just best to pay him and use it as a business expense?

If you hire your husband you will have to withhold Social Security taxes on his pay and he will have to pay income taxes on it. You and your husband should first talk to a person from your local Social Security office about the implications of him earning money after he starts collecting Social Security. You can certainly use your profit to invest in an IRA for yourself (SEP IRA, SIMPLE IRA, Roth IRA, or 401k IRA). All of these retirement plans will reduce your current year taxable income (with the exception of the Roth IRA). In general it does not make sense to hire your husband because you will save only a very small amount on your taxes if you do so. The only time it makes financial sense to pay your husband is if you have un-insured medical expenses that are over $1,000 a year. If so, you could hire him and then set up a medical reimbursement plan that can significantly reduce your taxes. For details on hiring your husband, see the Family Child Care Tax Workbook and Organizer.

My wife runs a childcare business out of our home. She is hiring an employee to start in August. I am wondering if she is subject to the Fair Labor Standards Act or the Minnesota Labor Statutes. Under the FLSA she would need to pay overtime for each hour of work over 40 hours. Under the Minnesota standard she would need to pay overtime for every hour worked over 48 hours.

Since the federal and Minnesota laws are different in regards to overtime, you must follow the rule that is the stricter. In this case, that's the federal law. Therefore, you must pay overtime for all hours over 40 hours per week. If you lived in a state where the state law was stricter than the federal law, you must follow the state law.

I have had a regular employee for two years but am now planning to hire someone occasionally to work for me instead. If I subcontract a substitute, what am I obligated to cover as an employee (regarding workers comp, taxes, insurance etc.)? Also, what are the minimum hours annually I can hire someone and not have to worry about withholding taxes, etc.?

You must withhold federal Social Security taxes on anyone you hire as an employee regardless of how little you pay the person. There is no minimum number of hours where this is not the case. If you pay a total of less than $4,000 in wages to all employees for a year, then you can choose to not file the quarterly Form 941 to pay social security taxes.  Instead, you can file the new (2006) annual Form 944 and pay these taxes at the end of the year. Your state determines when an employee is eligible for workers compensation and state unemployment. So, contact your state department of labor to find out if a part time worker is eligible. If the part time person you hire is actually self employed in the business of providing substitute care for a number of providers then you could treat this person as an independent contractor and not have to withhold taxes. This person needs to have a business name that is registered with your state, a business id number, and use a contract with you.

If I hire my own grandchild to do work for my business, do I have to pay any withholding taxes?

Yes. Normally, if you hire your own children who is under age 18 you do not need to pay any social security or medicare taxes. But if the worker is your grandchild, you must withhold and pay in social security and medicare taxes. The same is true for nieces, nephews, and other relatives outside of the parent-child relationship. Foster children under age 18 are considered as children and are not subject to these taxes.

If I hire a substitute and pay her less than $600 in a year, do I have to file any tax forms or pay any withholding taxes?

Yes. Anyone who works for you by caring for children in your home is your employee. You must withhold social security taxes and perhaps federal and state unemployment taxes. Your state may also require you to pay worker's compensation. It doesn't matter if you pay a person only a few hundred dollars in a year. Many providers are not treating such people as employees and could get into trouble later. An exception to these rules is someone who is in the business of providing substitute care and works for other providers. Such a person is an independent contractor. If you pay an independent contractor $600 or more in a year, you must file Form 1099MISC with the IRS.

Is it true that I can avoid the capital gains tax on the sale of my home if I just make sure I go out of business in the year before I sell it?

An IRS ruling from 2002 says that providers can avoid paying capital gains tax on the first $250,000 if you are single ($500,000 if married) as long as you owned the home and lived in it for two of the last five years. You will always owe tax on the depreciation you claimed (or were entitled to claim) after May 6, 1997.

How long do I need to keep my records in case of an IRS audit?

Keep your business records for at least three years after you filed them with the IRS. If you filed your 2004 tax returns on April 14, 2005, save these records until at least April 15, 2008. You should, however, save records for items you are depreciating for as long as the depreciation period lasts (furniture and appliances 7 years, computer 5 years). You should also save records on the buying and selling of homes and any home improvements for as long as you live. The IRS can only audit you back three years, with two exceptions: 1) if you committed fraud, or 2) if you underreported your income by at least 25%.

I am a tax preparer. My client is not licensed. Can she claim expenses on Form 8829?

If she is exempt from state licensing rules, she can claim expenses on Form 8829. If she is illegal, she cannot. See IRS Pub. 587 Business Use of Your Home.

One of my parents wants me to sign a receipt for her company's child care plan at the beginning of the month, but I get paid every week. I am nervous about doing this. What do you think?

Do not sign any receipt unless you have already been paid. If the parent wants you to sign a receipt for the upcoming month, do so only after receiving all the money owed you for that month. If you sign it and the parent doesn't come back, the IRS will assume that you got the money and require you to pay taxes on it.

I'm just starting my business and I'm not familiar with what I should put in my contract. Do you have any suggestions?

Your contract should have these four elements: 1) the names of the parties, 2) specific financial terms of how much and when the parent pays and when you will provide care, 3) details of how the contract can be terminated (parent must give a two-week notice), and 4) signatures of both parties. I would also suggest requiring parents to pay at the beginning, not the end, of each week, and require them to pay you for the last two weeks of care when they first bring their child.

A parent just left my care. Am I required to give him a receipt showing how much he paid me for the three months they were here?

No. There is no legal requirement that you give parents a receipt. But it is a good idea to do so. You want to make sure that the parent reports on his child care credit tax form the same amount that you actually got. So, give him a receipt and ask him to sign a copy. Keep one copy for your records.

How much liability insurance should I get for my business?

As much as you can. Nobody who was sued ever complained about how they had too much insurance. 100% of the cost of liability insurance is deductible.

Can I charge a parent more to care for her child who has a severe disability? The child takes a lot more time than the other children.

No. The Americans with Disabilities Act clearly prohibits charging more to care for children with disabilities. You could, however, raise every parent's rates.

A local attorney is recommending that providers incorporate their businesses. Do you think this is a good idea?

Generally not. There are some tax benefits of incorporating. But there are also significant drawbacks, including more record keeping, increased tax preparation fees, possible state fees, loss of Tier I Food Program eligibility if you are low income, and more. Providers should look very carefully at the pros and cons of incorporating before doing so.

I'm starting my business in a few months and I want to use as my business name, "Cindy's Playhouse." Do I have to register this name?

Check with your state's Secretary of State office for rules about registering a business name. In general, if you use your full name, you don't have to register it. But any other business name probably needs to be registered. If you don't, someone else can use that name (or is already using it) and can prevent you from using it. The fee to register your name is usually very small.

Can I set up a SIMPLE IRA even though my husband has a 401k retirement plan?

Yes. You are always eligible to set up a SIMPLE IRA, even if your husband has a retirement plan at work. There is also no income limitation to eligibility.

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

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