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Jonelle Marie Broady v. Commissioner

 by Tom Copeland

Citations: Jonelle Marie Broady v. Commissioner;

T.C. Summ. Op. 2008-63; No. 14675-06S

Date: Jun. 5, 2008 JONELLE MARIE BROADY, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

UNITED STATES TAX COURT

Filed June 5, 2008

Jonelle M. Broady, pro se. Veena Luthra, for respondent. Goldberg, Special Trial Judge:

This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. Respondent determined a $3,579 deficiency in petitioner's income tax for 2003. The issues for decision are: (1) Whether petitioner operated a daycare business out of her home during the year in issue, and if so, whether she is entitled to claim certain business-related expenses, and (2) whether petitioner is entitled to claim certain tax credits (a child tax credit, an additional child tax credit, and the earned income credit (EIC)) for the year in issue.

Background

Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioner resided in Maryland when she filed her petition.

In 1992 petitioner and her boyfriend (the couple) moved into a rented home in Bowie, Maryland. The house was a Cape Cod-style house situated on approximately one-third acre. The house had five bedrooms, 2-1/2 bathrooms, a large living room, and a large backyard. Petitioner has four children. The couple never married.

Petitioner did not work outside of the couple's home. Petitioner's sister and her boyfriend's sister asked petitioner to provide daycare services for their children in the couple's home. Although petitioner did not envision starting a daycare business per se, she soon found herself the recipient of multiple inquiries for her services from neighboring parents, parents at her children's daycare and school, and parents she met while shopping in the supermarket. On the basis of this response, and her desire to make money, petitioner decided to operate a daycare business in the couple's home.

In 2003 petitioner had at least eight children enrolled in her daycare, not including her own four children, two of whom stayed home with her during the day. Three of the children belonged to her neighbors. Four of the children belonged to either her sister or her boyfriend's sister. At least one other child belonged to a parent she met while shopping.

Petitioner's daycare service operated 5 days per week, from early morning through the early evening. Petitioner provided breakfast, lunch, and two snacks to the children in her care. The daycare activity occupied the family room, dining room, and kitchen of the couple's home. Petitioner would sometimes take the children in her care on field trips to places such as the National Zoo in Washington, D.C. When making such field trips, petitioner would use her vehicle, a 1985 Chevrolet Cavalier station wagon, to transport herself and the children.

Petitioner charged for her services according to the length of time that the child was in her care each day. If the child was in petitioner's care for the full day, the charge was $80 per week. If the child was in petitioner's care only after school, then the charge was $60 per week. On occasion, petitioner would negotiate a lower fee for parents whom she knew to be single parents with one income. Petitioner accepted only cash. The parents would pay either at the end of the week or at the end of every other week, pursuant to their pay cycle. At the end of each calendar year, including the year in issue, petitioner would provide the parents with a dated receipt showing the total number of weeks of childcare she provided for their child(ren) and the total cost. Petitioner included her name and full address of the child(ren) on the receipt, as well as her "Tax ID" number. The "Tax ID" number provided on these receipts was actually petitioner's Social Security number.

Although she had taken a childcare course years before she started her service, petitioner did not have a daycare license and did not have either a business phone line or a business checking account. When petitioner was paid in cash, she usually used the bulk of the money to purchase items for the daycare, her household, or for herself and her children. Petitioner would deposit whatever cash was remaining after these purchases into her personal checking account.

Petitioner had a set of business cards made which advertised her daycare service, and she placed advertisements for her service in the local "Pennysaver" gazette.

Petitioner ceased her daycare service in November of 2003. Petitioner moved out of the couple's home sometime in 2004.

Petitioner prepared her timely filed 2003 Federal income tax return using TurboTax. Petitioner reported $22,070 of wage income and $7 interest and claimed the following tax credits: (1) A $593 child tax credit; (2) an additional $1,157 child tax credit; and (3) a $2,422 earned income credit.

On May 2, 2006, respondent sent petitioner a notice of deficiency wherein respondent determined a deficiency of $3,579, resulting from the disallowance of the additional child tax credit and the earned income credit on the ground that petitioner did not have income for 2003 that would entitle her to claim those credits.1 Respondent also determined that petitioner had nonemployee compensation of $325 for 2003. Petitioner concedes that she did receive this income but failed to report it on her return.

Petitioner timely filed her petition. Subsequently, petitioner submitted a Form 1040X, Amended U.S. Individual Income Tax Return, for 2003 to respondent. Petitioner attached a Schedule C, Profit or Loss From Business, to her amended return and reported on that schedule gross income of $27,395 for 2003. Petitioner also reported on that schedule expenses related to advertising, car and truck expenses, office expenses, repairs and maintenance, supplies, utilities, and other expenses. These expenses totaled $12,445.

Petitioner deducted: (1) Advertising expenses of $200, which included the cost of business cards that she had printed and advertisements placed in the "Pennysaver" gazette; (2) car and truck expenses of $1,295 related to mileage, insurance, and repairs for the 1985 Chevrolet Cavalier; (3) $6,500, which included the cost of office supplies such as pens and paper which she used in her daycare service; (4) repairs and maintenance expenses of $220; (5) supply expenses of $630, which included expenses related to arts and crafts supplies; (6) utility expenses of $1,780; and (7) other expenses of $1,820, which related to food costs associated with her feeding the children in her care.

Discussion

In general, the Commissioner's determination as set forth in a notice of deficiency is presumed correct and the burden of proof is on the taxpayer to prove otherwise. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). Tax deductions are a matter of legislative grace, and the taxpayer bears the burden of proving entitlement to deductions claimed on a return. Rule 142(a)(1); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).

Under certain circumstances the burden of proof with respect to relevant factual issues may shift to the Commissioner under section 7491(a). The burden of proof may shift to the Commissioner under section 7491(a) if the taxpayer establishes compliance with the requirements of section 7491(a)(2)(A) and (B) by substantiating items, maintaining required records, and fully cooperating with the Secretary's reasonable requests. As discussed below, we find that petitioner has failed to substantiate her claimed expenses and maintain required records. The outcome of this case, however, will be based on the preponderance of the evidence standard and thus is unaffected by section 7491. See Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005).

Although respondent had not accepted petitioner's amended tax return as of the date of the trial, respondent's litigating position is that petitioner's daycare was not a business operated for profit in 2003; and that even if the Court determined that it was, petitioner has failed to substantiate both her income from that activity and the aforementioned expenses.

Section 162(a) allows deductions for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. To be engaged in a trade or business within the meaning of section 162(a), an individual taxpayer must be involved in the activity with continuity, regularity, and with the primary purpose of deriving a profit. Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987). Deciding whether the taxpayer is carrying on a trade or business requires an examination of all of the facts in each case. Id. at 36.

Although a reasonable expectation of a profit is not required, the taxpayer's profit objective must be actual and honest. Dreicer v. Commissioner, 78 T.C. 642, 644-645 (1982), affd. without published opinion 702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs. Whether a taxpayer has an actual and honest profit objective is a question of fact to be answered from all of the relevant facts and circumstances. Hastings v. Commissioner, T.C. Memo. 2002-310; sec. 1.183-2(a), Income Tax Regs.

On our review of the record, we conclude that petitioner operated a daycare business in the couple's home during 2003 with continuity, regularity, and with the primary purpose of making a profit. Petitioner watched at least eight children each weekday in her home from January through November of 2003. Although she did not hold a license or have a separate phone line for her business, we are convinced that she operated her daycare service in a reasonable manner as compared to other similar home-based daycare services. That is, while we do not condone petitioner's lack of a license, we are convinced from her testimony that she did in fact provide daycare services each weekday for 11 months of 2003 and that her stated goal ("to make money for [the couple's] household") adequately satisfies the profit motive requirement. In fact, petitioner's amended return shows a $14,950 profit for 2003. Therefore, we are satisfied that petitioner operated a business within the meaning of section 162(a) for the year in issue.

We are further convinced that petitioner received $17,950 in income from her business for 2003 as evidenced by an adding machine tape received into evidence by the Court and her credible testimony that the tape reflected amounts she received. On the basis of the entire record, we believe that the figures on the adding machine tape represent the most accurate record of the amounts that petitioner actually received for her daycare services for 2003.

Petitioner did provide copies of receipts akin to those that she provided to parents at the end of 2003 for daycare services rendered in that year. These were not, however, actual copies of those receipts. Petitioner compiled these receipts for trial from her recollection of records she maintained at the couple's home, which she no longer had access to. Each one of these receipts notes the name(s) and addresses of the child(ren) during 2003 as well as the addresses of the child(ren) as of the date of trial. While we view these receipts as support for petitioner's testimony that she did, in fact, have at least eight children enrolled in her daycare for 2003, we are not confident that the total charges reflected after adding up these receipts ($22,190) represent petitioner's income from her daycare for 2003.

Petitioner has failed to substantiate any of the Schedule C expenses for her daycare for 2003. The scant evidence she provided consisted only of copies of her checking account statements for 2003 and canceled checks made payable to Baltimore Gas & Electric. The only testimony offered was with respect to petitioner's advertising costs, car and truck expenses, supplies, and other expenses. Petitioner testified as to having printed business cards and placing advertisements in the "Pennysaver" gazette, using her car for occasional field trips with the children, buying arts and crafts supplies, and feeding the children at least two meals and two snacks each day. Petitioner did not, however, provide any records or receipts to substantiate any of these expenses, copies of her business cards, or copies of the advertisements, and she did not introduce any evidence on which we may estimate the amounts that she paid for such expenses during 2003. On the record before us, we conclude that it would be inappropriate for us to estimate that amount. Cf. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).

Finally, and with respect to petitioner's entitlement to certain tax credits (a child tax credit, an additional child tax credit, and the EIC), respondent disallowed these credits on the basis of his determination that petitioner had adjusted gross income of $325, and no tax liability, for 2003. An eligible individual is entitled to an EIC against the individual's income tax liability, subject to certain requirements. Sec. 32(a)(1). Different percentages and amounts are used to calculate the credit depending on whether the eligible individual has no qualifying children, one qualifying child, or two or more qualifying children. Sec. 32(b). To be eligible to claim an EIC with respect to a "qualifying child", a taxpayer must establish, inter alia, that the child bears one of the defined relationships to the taxpayer specified in section 32(c)(3)(B). Under section 24(a) and (c) a taxpayer may be entitled to a child tax credit with respect to each qualifying child under the age of 17 as described in section 32(c)(3)(B).

Respondent does not dispute that petitioner had two qualifying children for which she would be entitled to an EIC and/or a child tax credit. Respondent's disallowance is based solely on petitioner's income for 2003. Respondent determined that petitioner had only $325 in income for the year in issue. We have concluded that petitioner had $17,950 in gross receipts for 2003 from her daycare business, but she is not entitled to claim expense deductions for any of the amounts reported on Schedule C of the amended income tax return as they have not been substantiated. Accordingly, and to whatever extent therefore allowable under sections 24 and 32, respectively, petitioner is entitled to an EIC, a child tax credit, and an additional child tax credit for 2003.

In the light of our conclusion that petitioner had $17,950 in income from her daycare business for 2003 (in addition to the $325 in nonemployee compensation that she received for that year), petitioner's correct tax liability must be computed so as to determine whether petitioner is entitled to a child tax credit, an additional child tax credit, and an EIC for the year in issue.

To take account of the necessary recomputation of petitioner's correct tax liability for 2003,

Decision will be entered under Rule 155.

Footnote

1 Form 4549, Income Tax Examination Changes, does not include the $593 child tax credit taken on petitioner's income tax return but rather lists "0.00" for the credit. As the examination determined that petitioner had adjusted gross income of $325 for the year in issue, and, accordingly, a corrected tax liability of zero for 2003, petitioner would not have been entitled to a child tax credit for that year under sec. 24(b)(3).

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Phyllis Rosales - Provider Saves Thousands of Dollars in IRS Audit

 by Tom Copeland

When family child care provider Phyllis Rosales of Kansas City, Missouri, was told by an auditor of the IRS over three years ago that she owed over $14,000 in taxes and penalties, she decided to fight back and call Tom Copeland for help. Last month Tom settled her case with the IRS and saved Phyllis over $8,000. The original auditor clearly did not understand basic family child care tax rules. She told Phyllis that she couldn't deduct something if it had any personal use and denied deductions for cable television, house repairs, furniture and appliances, cell phone, Internet use, business interest on a credit card, and much more.

She also asserted that Phyllis had a Time-Space Percentage of 22% rather than the 46% claimed by the provider. She denied the business space use of the garage, the provider's bedroom and her daughter's bedroom as well as part of the basement. She also denied many business hours the provider worked after the day care children were gone. In addition, the auditor charged Phyllis over $2,400 in accuracy related penalties for "intentionally" disregarding rules and regulations. (The Tax Court lawyer threw out these penalties.) The provider made some mistakes on her tax return. She claimed 100% of the cost of household items such as a CD player, camera, dishwasher, computer, furnace cleaning, dryer repair, and garage door repair.

In the settlement, the IRS agreed that she was entitled to deduct her Time-Space Percentage of these expenses. Phyllis also deducted expenses related to her cat (food, litter, and vaccinations) that should not have been claimed. (In assisting providers over the past 20 years, I have never won a deduction for a dog or cat!) Here are some lessons that providers can take from this case:

Providers are entitled to claim their basement and garage as part of their Time-Space Percentage if they can show that these areas are used on a regularly basis in their business.

Phyllis worked an average of 16 hours a week after the day care children were gone doing activities such as cleaning, record keeping, activity preparation, etc. Although 16 hours is higher than most providers, Phyllis won because she kept a daily record of these hours on her calendar for each month of the year.

Most providers do not keep such complete and accurate records of the hours they work when children are not present. In my workshops and books I recommend that providers keep at least two months of such records. I still think this is a reasonable goal. But in this case where the provider worked such long hours, recording her hours for the entire year, made a difference.

In addition to the extra 16 hours a week, Phyllis also claimed another 297 hours spent studying at home to receive her Early Childhood Degree. Her degree was not deductible because it was her first post secondary degree. (Note: If providers already have a post-secondary degree and get a second degree, the cost of the second degree is deductible.) The IRS took the position that since the degree was not deductible, the hours spent studying at home could not be counted. I have not faced this issue before and we agreed not to count these hours. In the end the IRS allowed Phyllis to claim a Time-Space Percentage of 42.7%.

Phyllis had hired her 17-year old daughter and husband in her business and established a medical reimbursement plan that allowed her to deduct medical expenses for her business. She kept excellent payroll records. The auditor believed that providers could not establish such plans even though the Tax Code clearly allows it. Because of the recent Tax Court case (see the Speltz case) won by Tom, the Tax Court lawyer quickly allowed the deduction (over $2,400) in this case. Providers who intend to set up a medical reimbursement plan and hire their family members should seek professional tax advice before doing so to make sure they follow all the proper rules.

Many providers deduct 100% of items that can also be used by their family (furniture, supplies, toys, etc.). If you are doing this, you need to be able to prove that your family never uses such items. This is relatively easy for things such as children's furniture, but can be much more difficult for items such as a rocking chair or CD player. A safer position to take would be to only claim a business deduction of 90% so as to appear more reasonable even though the items may actually be used 100% by the business.

Persistence pays off. I talked with Phyllis numerous times over the phone and urged her to keep fighting because I believed the IRS positions were not supported by the Tax Code. She did everything she could: responded to all requests for information from the IRS, wrote letters, sent copies of Tax Court cases, and talked to the supervisor of the hearing officer when the officer would not look at her records. She then took the next step and appealed her case to Tax Court. She gave me all the records I needed to represent her and after three years she won a significant victory. After her victory, Phyllis wrote to us:

"Tom if it wasn't for you I would not have been able to fight my fight. I would have had to let the powerful IRS win, even though I knew they were wrong on many issues. I would not have had the resources that you offered me. For me it was not just the money, my integrity was in question and my savvy as a business owner. I have always prided myself with being an honest person and doing the right thing. If it wasn't for you and your dedication to my cause, I'm afraid I would have given up and not have the satisfaction that I feel knowing that I was just and you helped me prove that. What a boost for my self-confidence!"

This is the fifth Tax Court case involving a family child care provider that I have handled. In all cases the provider saved a substantial amount on her taxes.

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Robert Neilson and Dorothy Neilson v. Commissioner

 by Tom Copeland

Tax Court Decision 94-1, 1990 Time-Space Percentage

Respondent's Deficiency Determination

During 1983 and 1984 petitioners operated a licensed day-care center in their home. Petitioners purchased their 3,000-square-foot home in 1981 for $119,624, of which $75,285 was allocable to the house. Eighty-nine percent of the 3,000 square feet of space was utilized for day-care purposes. The schedules below reflect the amount of deductions claimed by petitioners and allowed by respondent for the 1983 and 1984 taxable years.

Respondent determined that petitioners' use of their residence for day-care services was 75 hours per week. Respondent's estimate was based upon a log kept by petitioners that reflects the times and days that children were in petitioners' care.

In addition to the time children were actually present in petitioner’s residence, petitioners spend about 2 hours each morning organizing the facility and preparing luncheon meals for the children. Petitioners also spent about one hour each evening after the children departed; cleaning and reorganizing the day-care facility. Respondent did not consider the preparation and clean-up time in estimating 75 hours per week. Petitioners, on occasion, also provided day care on weekends. Respondents formula did not consider the weekend use of petitioners' residence. Petitioners utilized their residence for day-care business purposes for an average of 90 hours per week or 54 percent (90/168) of the time.

Petitioners claimed and respondent disallowed $532 and $608 for lawn care in 1983 and 1984 respectively. During 1983 and 1984 petitioners used the lawn areas around their residence for day-care business purposes. During 1983 and 1984 petitioners paid $532 and $608, respectively for lawn care expenses, 54 percent of which is deductible in each taxable year.

Type of Deduction	Claimed in 1983	Allowed in 1983	Claimed in 1984	Allowed in 1984
Depreciation*	$5,057.00	$1,994.00	$5,057.00	$1,994.00
Lawn Care	532.00	0	608.00	0
Utilities	753.94	792.00	1,348.37	602.37
Repairs	960.00	442.90	0	0
Insurance	425.00	190.00	697.59	311.59
Real Estate Tax	1,369.44	611.44	1,464.29	654.29
Interest-Mtg.	5,455.17	3,171.17	7,035.85	3,912.86

*Petitioners claimed ACRS depreciation on the straight-line method for a 15-year useful life. Respondent determined that only 89 percent of the residence was used for day-care purposes and that day care was provided for only 75 out of a possible 168 hours per week, or 44.6 percent of the total time available for use. With the exception of the lawn care, which was disallowed completely, all other deductions were reduced to reflect the 89-percent and 75-hour factor determined by respondent.

Respondent concedes that any disallowed portion of real estate tax and interest would be deductible as "Schedule A" items. Petitioners concede that for 1983 the amount of interest claimed exceeded the amount they could verify and that they are therefore not entitled to $119 of the total deduction taken. Petitioners also concede that their personal use of the residence constituted 11 percent and, accordingly, only 89 percent can be considered for business purposes. 

Income Tax Deficiency-Merits

Generally, under Section 280A, no deduction otherwise allowable shall be allowed with respect to the use of a dwelling unit which is used by a taxpayer as a residence during the taxable year. An exception to the general rule exists where the residence is used exclusively and on a regular basis as the principal place of business for any trade or business of the taxpayer. Sec. 28OA(c) (1). Additionally, where a taxpayer uses a dwelling unit on a regular basis for day-care services, a deduction maybe allowable based upon percentage of use. Section 28OA(c)(4)(C) provides for a deduction in an amount equal to the expenses attributable to that portion determined by multiplying the total amount of the expense by a fraction, the numerator of which is the number of hours the portion is used for day care business purposes and the denominator of which is the total number of hours that the portion is available for use. Sec, 1.280-2 (i) (4), Proposed Income Tax Regs., 45 Fed. Reg. 52399 (1980), amended 48 Fed Reg. 33320 (1983).

Petitioners bear the burden of proving the amount of their use and their entitlement to a deduction. Welch v. Helvering, 290 U.S. 111 (12 AFTR 1456) (1933); Rule 142(a). Initially, petitioners have conceded that 89 percent of their residence was utilized for day-care purposes and that 11 percent was used for personal use.

Petitioners maintained a log which reflected the name of the child, the date, and time spent at petitioners' residence. Respondent, based upon the log, determined that petitioners used their residence about 75 hours per week. Based upon petitioner: testimony, we have determined that petitioners used their residence about 90 hours per week. Our finding is based upon that preparation and clean-up time which is not reflected on petitioners' log and upon the fact that petitioners occasionally provided day-care service on weekends. Respondent's determination of 75 hours per week is apparently based upon a 5-day week and 13-hours use per day. With 90 in the numerator and 168 in the denominator, petitioners would be entitled to 54 percent of 89 percent of the items claimed on their returns in connection with day care, except for the lawn care. The 89 percent limit does not apply to the lawn care because it appears that the children had exclusive use of that area during the time day care was being provided. Accordingly, 54 percent of the $532 and $608 claimed for lawn care in 1983 and 1984 respectively is allowable.

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Phyllis Rosales Tax Court Settlement Notes

 by Tom Copeland

Below are the settlement notes that I prepared for my meeting with IRS attorneys to settle this case before a Tax Court trial.

Health insurance deduction

Taxpayer position: $1,480 Schedule C deduction

IRS position: $0

Taxpayer claimed $1,480 in health insurance premiums as business deductions on Schedule C as part of a medical reimbursement plan for her employee (Mr. Rosales).

The IRS took the position that the taxpayer could not deduct health insurance payments because she is eligible to participate in her husband's medical plan.

A recent Tax Court case directly addresses this issue (T.C. Summary Opinion 2006-25) where the court ruled that a family child care provider could deduct such expenses as part of a medical reimbursement plan for her employee husband.

The court said:

"Under section 162(l), a self-employed taxpayer may deduct the cost of medical insurance premiums under certain conditions. A self-employed taxpayer may not deduct the cost of medical insurance premiums, however, if the self-employed taxpayer is eligible to participate in a subsidized health plan of another employer of the taxpayer or of a spouse's employer. Sec. 162(l)(2)(B).

"Mrs. Speltz is self-employed. She deducted on the daycare Schedule C the cost of medical insurance premiums paid for Mr. Speltz under the daycare's accident and health plan for employees, and she was eligible to receive medical benefits through Mr. Speltz's subsidized health plan with Fastenal, his full-time employer.

"While section 162(l) applies to Mrs. Speltz because she is self-employed, section 162(l) does not apply to Mr. Speltz. See sec. 162(l)(1)(A), 401(c)(3). Because the premiums were paid for medical insurance for Mr. Speltz, the limits of section 162(l) and section 162(l)(2)(B) do not apply. Accordingly, petitioners are entitled to deduct their expenses for medical insurance premiums for Mr. Speltz." In our case Mrs. Rosales hired her husband and her daughter and these wages ($4,783) were allowed as a business expense by the IRS examiner. The tax examiner has admitted that there was a bona fide employer/employee relationship. Mrs. Rosales hired A&T Inc. to establish her medical reimbursement plan (see enclosed document). Mrs. Rosales followed the terms of her plan and the premiums paid by Mrs. Rosales were for the benefit of her employees. Therefore she should be allowed to claim this deduction on her Schedule C.

It appears that Mrs. Roseles' tax preparer mistakenly put the $1,480 in reimbursed health insurance expenses on Form 1040 (subject to the 60% limitation) rather than on Schedule C as her business expense.

Because taxpayer established a medical reimbursement plan she is also entitled to deduct other employee medical benefits ($2,455 for 2001 and $2,970 for 2002). The auditor documented receiving receipts for these amounts. The auditor notes that in 2002 Mr. Rosales did not spend about $800 of the money set aside for medical expenses in his cafeteria plan. This is still deductible to Mrs. Rosales because it was for the purchase of medical insurance (house insurance is still deductible even if no claim is made during the year). Even though all of the money set aside was not spent, the balance was returned to the company and not received by the Rosales family. So, this represents a medical expense to Mr. Rosales that was reimbursed by Mrs. Rosales.

To deduct medical expenses under a medical reimbursement plan it is not necessary for the employer to pay a salary (see the Speltz case where the provider paid no wages to her employee husband). In our case, in 2001 the provider paid her husband $576 in salary and her daughter $4,207, for a total of $4,783. Her husband worked approximately hours during the year and her daughter worked approximately hours (see attachment). When the amount of health insurance expenses and other employee benefits are added to their salary, they are still earning a reasonable wage for their work, or about $10 per hour.

Car/Truck Expenses

Taxpayer accepts the IRS position regarding the car/truck expenses for the years at issue.

Depreciation

The taxpayer claimed a home office business percentage of 42% and the IRS examiner allowed 22%. We are challenging this reduction (see discussion below). This percentage difference affects the depreciation for the house, roof, and dishwasher.

	IRS Position	Taxpayer Position
Property	Home	Home
Cost Basis	$80,000	$80,000
Business %	22%	46%
Business Basis	$17,600	$36,800
Method	39yr SL	39yr SL
Deduction	$464 (2001)	check tables
	$451 (2002)
Property	Roof	Roof
Cost Basis	$7,234	$7,234
Business %	22%	46%
Business Basis	$1,592	$3,328
Method	39yr SL	39yr SL
Deduction	$2	$85
Note: Examiner's math wasincorrect. The correct deduction using a 22% business use would be   $41, not $2.
Property	Dishwasher	Dishwasher
Cost Basis	$555	$555
Business %	22%	46%
Business Basis	$122	$255
Method	7yr SL	7yr SL
Deduction	$17	check tables

Taxpayer cannot find her records of the equipment purchased in July 1998 and October 2000 so we are not challenging the denial of the deduction for these items.

Taxpayer purchased two rocker/recliners in a two-for-one sale (cost?). She used one of the rocker/recliners exclusively for her business by rocking the children to sleep. It was also used by the parents of the children when were in her home. The second rocker/recliner was used by both her business (used by the day care parents and by the day care children) and her own family. Originally the taxpayer claimed 100% of the cost of both rocker/recliners. Upon review we are requesting a deduction of 100% of the cost of the first rocker/recliner and the Time-Space percentage cost of the second rocker/recliner.

The Bose radio was a combination radio, DVD and CD player (cost?). The taxpayer used this equipment in her business when she played music CDs for the children. She also had her record player connected to the Bose speakers when she played records for the children. The Bose system was used several times each week. This use is clearly ordinary and necessary. Taxpayer originally claimed 100% of the cost of this item and upon review we are requesting to deduct the Time-Space percentage of this cost.

Van - The IRS disallowed the cost of the finance charges for the van and for the service contract. These items should have been allowed as a proper van expense. It is not clear from the record whether the business portion of these expenses were allowed on Schedule C.

Computer, playhouse, camera - TS% or 100%?

Legal and Professional Services

Taxpayer position: $300

IRS position: $390

The IRS examiner allowed taxpayer to deduct $90 paid to the A&T Inc. and Business Tax Service for preparing payroll taxes. We accept this position.

Repairs and Maintenance

Taxpayer position: $1,108 Schedule C deduction

IRS position: $13

The IRS allowed the expenses for exterminating, duct cleaning, and carpet cleaning on Form 8829 where it was deducted using the Time-Space percentage. We accept this position for the extermination, and carpet cleaning cost. We believe we are entitled to deduct 100% of the cost of the duct cleaning (how much?). In 2002 the taxpayer cared for a child with asthma. Taxpayer is required to comply with the rules of the Americans with Disabilities Act to accommodate children with disabilities. She had her house ducts cleaned to improve the air quality of her home and make it easier for this child to remain in her program. She had never before had her ducts cleaned and she has not had them cleaned again since.

It appears that the IRS hearing officer also disallowed the cost of cleaning the furnace, dryer repair, lawn mower repair, garage door repair, and Roto Rooter. It is not clear if these items do appear on Form 8829. All of these expenses are clearly ordinary and necessary for the maintenance of her home business. She must have her furnace, dryer and lawn mower in good repair to run her business. She must have her house plumbing system in good repair as well. Although the taxpayer originally claimed these items as 100% business, upon review we believe these should be deducted on Form 8829 and apply the Time-Space percentage.

Travel Expense

2001

Taxpayer position: $857

IRS position: $802

2002

Taxpayer position: $2,531

IRS position: $78

In 2001 taxpayer traveled three and a half hours each way to Springfield, MO to purchase leather craft supplies at a leather goods store. She spent approximately three to four hours in the store getting instruction on how to use the leather materials in various craft projects with her children. There was no similar store in her hometown where she could purchase these materials. Taxpayer does not remember if she bought other personal items in Springfield on this trip, but it is likely that she did. Taxpayer is allowed to deduct miles for trips if the primary purpose of the trip is business related. In this case, the primary purpose was to buy leather craft supplies. The trip to Springfield was primarily for business purposes and therefore the cost of the hotel ($54) in Springfield is an ordinary and necessary business expense.

Hawaii conference

Taxpayer attended a week-long business conference in Hawaii and deducted the cost of this trip, along with the cost of the trip for her daughter who was her employee.

IRS Code Section 162 allows travel expenses while away from home in the pursuit of a trade or business as long as the "primary" purpose of the trip was business.

The IRS MSSP Child Care Audit Guide states: "Travel away from home overnight may consist of attending seminars."

The taxpayer tried to book a flight for the business conference immediately before the conference began (December 1st) but could not get a flight that left any later than November 24th. She spent November 24th as a travel day. She then spent 6 days in Hawaii before the conference began. The conference lasted 6 days and then she spent another travel day getting home. She was away from her home a total of 14 days. Two of these days were travel days. According to IRS Publication 463 Travel (look up) taxpayers are allowed to count their travel days as business days in determining the primary purpose of a trip.

During the 6 days attending the business conference, she spent 21.5 hours in workshops, plus an additional 6 hours walking to and from her hotel to the conference site (1/2 hour each way). She also spent an additional 5.5 hours during the 6 day conference visiting a local family child care home where she talked to a provider who used the Montessori philosophy with her children. The conference organizer gave her a Hawaiian Culture Sticker for these 5.5 hours. Taxpayer submitted records of her attendance at the conference workshops and the extra hours on this Sticker. This makes a total of 27 hours of business activities during these 6 days.

During the 6 days the taxpayer spent in Hawaii before the conference began she also spent time on a variety of activities that she used to enhance her child care business once she returned home. She took many photos of a Buddhist Temple (to teach children about other religions), lighthouses and other landmarks, Botanical Gardens (she brought back plant starts to try and grow a tropical garden for the children in her home), dolphins (to show children unusual animals), pineapple plantation (she bought a book to help teach children how to grow pineapples - she still has a pineapple plant growing in her home), and Christmas parade (to show children how the holiday is celebrated differently in Hawaii). In addition, taxpayer spent 2 and a half hours visiting the Hickam Air Force Base Child Care Family Services office where went to learn about the different licensing requirements and other qualifications providers had in Hawaii (ask her about this).

The six days spent at the conference were primarily for business purposes because she spent more than half of the time each day on business activities. If we add the two travel days as business days, the total is eight business days. During the other six days in Hawaii the provider spent a number of hours on activities that she used in her business upon her return. This is not a case of a provider taking a vacation and conducting a few hours of business activities in an attempt to deduct the entire travel costs. The primary purpose of the trip to Hawaii was to attend the business conference and therefore the cost of the travel should be deductible.

Taxpayer deducted the hotel expenses for the 6 days she was attending the business conference ($693). The IRS denied this deduction. Clearly, this deduction is valid regardless of whether or not the travel expense is allowed.

In the first draft of the IRS examiner's report she did allow the taxpayer to deduct her trip to this conference.

Daughter's trip to Hawaii

Taxpayer's daughter has been her employee since 1999. She worked an average of 60 hours a month or a total of 720 hours a year. She was paid $4,300 in 1999, $4,300 in 2000, $4,300 in 2001, and $60 in 2002. The reason she worked fewer hours in 2002 was because she was away from home for several months and started another full time job. Her pay was approximately $6 an hour, so this conference an additional reward for all the work she had done for me in previous years. In 2002 her plans were to continue to work for my business in later years and she retained her state-approved status as a substitute. The daughter also attended workshops at the conference (see attached certificate). The knowledge she gained from attending the Hawaii conference would be put to use in her work as a substitute after her return home.

Meals and Entertainment

2001

Taxpayer position: $150

IRS position: $101

2002

Taxpayer position: $413

IRS position: $81

The meals in 2001 were for her trip to Springfield.

The meals in 2002 were for the Hawaii business conference. Since the 6 day conference was clearly business, the meals eaten during these 6 days should be allowed ($406 x 50% = $203).

Check into 2002 deduction

Schedule C Other Expenses 

2001	IRS Position	Taxpayer Position
Dues and cable	$540	$133
Telephone	$785	$272
Seminars	$155	$125
Exterminator	$415	$0
2002	Taxpayer position	IRS position
Telephone	$466	$248
Exterminator	$280	$0
Cable TV	$438	$0
Cell phone	$395	$0
Dues	$188	$120
Seminar	$639	$530
Internet	$287	$0
Note: IRS allowed the Exterminator expense on Form 8829 and we accept this position.

Cable Television

The IRS examiner's report states that cable television is strictly a personal expense and can never be deducted as a business expense. However, in the Simpson v. Commissioner Tax Court case (Tax Court Memorandum 1997-223, Mary 12, 1997) the court allowed the deduction of cable television as a business deduction on Form 8829 as a household utility. The court said, "Petitioners also deducted expenses relating to cable television, gas, electricity, telephone service, garbage removal, and water. The deduction for telephone service is expressly prohibited by section 262(b). The remaining utility expenses are deductible, subject to the limitations of section 280A(c)(4)." In the Simpson case the petitioners failed to provide sufficient evidence that they used the cable television in their business, but the court's ruling clearly states that cable television should be treated in the same manner as other household utilities. Therefore, we should be entitled to claim cable television on Form 8829.

Telephone

The disallowed phone expense was for a "works package" offered by the phone company. This extra service is on the first phone line in the home. This phone line is the advertised number used in the taxpayer's business. The "works package" allows the taxpayer to pick up an incoming call when the phone is in use and allows her to see if a parent or some other business-related call is coming in. The package also allows the taxpayer to use caller ID and to record phone numbers as a part of her business. IRC section 262(b) refers to the disallowance of "basis local telephone," not an extra feature such as a "works package." This extra business feature was not part of the basic phone service on the first telephone line. On her original tax return the taxpayer claimed 100% of this expense. Upon review we are willing to accept the Time-Space percentage of these expenses. Note: The Appeals Officer did allow $247 for the "works" package.

Seminars

The IRS examiner disallowed a $30 deduction for the cost of a frame for the taxpayer's diploma that she received for her Early Childhood degree. The taxpayer did not try to claim the cost of the college classes as a business expense. She framed this diploma and posted it on a wall in her entryway so her business parents could see her accomplishment. This is a marketing expense that helps the taxpayer to promote her business. Communicating this degree to parents strengthens her credentials. If the taxpayer had obtained a nursing degree before she began doing child care and framed her nursing degree to show her day care parents what credentials she had, this would also be considered an ordinary and necessary expense for her business.

Cell phone

Taxpayer used a cell phone for her business in the following ways: she carried it with her in the back yard for emergencies and so parents could reach her quickly. She took the phone on field trips with the children for the same reason. Because the taxpayer was caring for eight or more children at one time, it would not be convenient for her to rush to another room to answer the phone and leave the children behind. A cell phone is an efficient way to communicate with parents, and keep children safe, and therefore is ordinary and necessary. Originally, the taxpayer claimed 100% of this cost. Upon review, we are willing to accept the Time-Space Percentage of this cost as a business deduction.

Internet

Taxpayer used the Internet for her business in the following ways: she did research for her child development classes, she emailed day care parents and received emails from these parents, she visited the website of the National Association for Family Child Care to get information and news about the field, she visited the website of the Redleaf National Institute where she read their monthly newsletter. The use of the internet in a business is common and is clearly an ordinary and necessary business expense. This expense should be claimed on Form 8829 as a utility and apply the Time-Space percentage.

Business Use of the Home

Family child care providers are allowed to claim expenses associated with their home under IRC section 280(A). The calculation for this deduction is based on a formula of space and time.

Space

Taxpayer's home is divided into the following areas:

First floor

220 square feet - room used exclusively for business - accepted by IRS

1,005 square feet of areas used regularly for business - accepted by IRS (classroom, living room, dining room, bathroom, kitchen, one bedroom)

221 square feet - taxpayer's main bedroom and bathroom - not agreed by IRS to be regularly used for the business108 square feet - taxpayer's daughter's bedroom - not agreed by IRS to be regularly used for the business

Total: 1,554 square feet

Basement

1,554 square feet - The IRS hearing officer allows taxpayer to claim half of the square feet of the basement as regular use for business

Garage

483 square feet - not allowed by the IRS to be considered as part of the square feet of the home

Total square feet: 3,591

Basement

Taxpayer contends that this room is regularly used in her business based on the following facts: The basement is one open room. Taxpayer uses the basement for business activities on a daily basis. She does the laundry for day care children, gets cleaning supplies, removes food from the freezer and food off the pantry shelves. She replenishes art materials, rotates books and toys. All of these activities are directly related to her business. Taxpayer had to install a water sprinkler in her basement as a licensing requirement by the state fire marshal. Her day care children are required by the state to go into the basement every other month to practice a tornado drill.

The basement contains the following items that were used on a regular basis for her business.

Some of these items are used exclusively for her business and some of them are used by both her family and her business:

Washer/dryer

Work bench

Baby walker

Baby sit and spin

Parachute

Children's books

Shelving and dressers with arts and craft materials

Teacher resource library and notebooks

School posters

Felt theme kits

Stuffed animals

Case of paper

Baskets/trays

Cleaning supplies

Toilet paper

Yearly tax boxes

Freezer

Games

2 strollers

4 tubs of dress up clothes

Theme boxes

Cabinet with extra school supplies

Science equipment

Dolls

Children's golf clubs

Case of cutting strips

Paper table cloths

Food pantry

Christmas decorations

Furnace

Children's store

2 play pens

Hot water heater

Baby swing

2 racks of children's VHS movies

Month curriculum boxes

2 children's rocking chairs

3 filing cabinets with school papers

Math equipment

Soccer nets/balls

Tubs of assorted toys

Paper towels

Children's Christmas and birthday gifts

Photos of the basement are enclosed.

The issue of whether or not a basement is regularly used in the family child care business was addressed in the Uphus and Walker cases (TC Memo 1994-71). First, it is not necessary for children to be playing in an area for that area to be considered regularly used by the business. In both cases Minnesota state child care licensing laws prohibited the provider from bringing children into the basement areas. The court said, "The fact that the children were generally not allowed in the areas is not dispositive of the issue. The issue is whether the area in question is regularly used in the operation of the taxpayer's day-care business, not whether or not the children are present in that area."

In both the Uphus and Walker cases the providers used their basement areas for storage of day care items and they were in and out of the basement retrieving and returning these items. The court also noted that Mrs. Uphus used a freezer in her basement for day care food and both Mrs. Uphus and Mrs. Walker had a laundry room in their basement that they used on a regular basis in their business. Based on the significant use of the basement by Mrs. Rosales and comparing her use of her basement with the use by family child care providers Uphus and Walker it is clear that Mrs. Rosales does meet the standard of using her basement on a regular basis for her business.

Garage

Taxpayer contends that this room is regularly used in her business based on the following facts: Contrary to the IRS examiner's report, the garage has electrical outlets, overhead lighting, and has vents for heating and air conditioning. It is attached to the home and is used as an emergency exit in her business. Taxpayer did not store her car in the garage because there is no room for it. Taxpayer uses the garage at least three times a day, some days more. She would bring out the children's cots (14) and bedding and then return them each day after the afternoon nap. She would also enter the garage once a day to throw out trash from the business. Many times she had to put out diapers more than once a day.

Items stored in the garage included:

Covered trash cans

Kid size rakes

Tool box

Mower wagon

Yard tools

Kid size snow shovels

Riding lawn mower

Safety fencing

Shovels

Push mower

Push broom

Extension cords

Sleds

Bagger/Mulcher

Buckets

Yard leaf bags

Planting table with tools, pots, and dirt

14 children's cots

Shelving with auto items

10 car seats

Ironing board/irons

Laminator

Rubbermaid container on wheels with outdoor toys

Bench seat from 15 passenger van (to accommodate a child's wheel chair)

Shelving with paper cutter, Head Start Portfolios, baby monitor, Johnny jumper, calendar, bulletin

board items, electronic toys, extra parts for toys, chalk, coloring books, items left by children

no longer in attendance

Wooden cubbies

Children's bags of bedding

Ice melt

2 paint easels

2 bikes/helmets

Musical instruments

Tumble mat

Wet/dry vacuum

Newspapers

Hamster bedding

Cereal boxes

High chairs

Paint paper

Art work drying rack

IRS Publication 587: Business Use of Your Home states, "The term home includes a house, apartment, condominium, mobile home, or boat. It also includes structures on the property, such as an unattached garage, studio, barn, or greenhouse." Therefore, the garage should be considered as part of the total square of the home for purposes of calculating the home office deduction.

The IRS examiner argued that the garage should not be counted as part of the home because counting it would not increase the home expenses because it was not heated or air conditioned. In fact, the garage is heated and has air conditioning, as well as electrical outlets. In addition, the garage does increase home expenses. The garage was part of the purchase price of the home and is included in the depreciation deduction of the home. Its value is also included in the property tax calculation and the home insurance calculation.

The issue of whether or not a garage is regularly used in the family child care business was addressed in the Uphus and Walker cases (TC Memo 1994-71). In the Uphus case the provider was allowed to count her detached garage as regular use. In the Walker case the court ruled against the provider. Here is how the court distinguished these cases:

"The garage was used by Mrs. Uphus to park her car and store both day-care and personal items. Mr. Uphus' car was always parked on the street. The garage contained the majority of the outside day-care play items: i.e., scooter bikes, sandbox toys, wagons, a movable cardboard basketball hoop, a slide, etc. The garage was also used to store lawn chairs, lawn-care materials, tools, a snowblower, bicycles, and miscellaneous other items that were stored in the rafters.

"During an average day, Mrs. Uphus and the older children were constantly entering the garage to retrieve and return the outdoor play items; the young children were not allowed to enter the garage unsupervised. A few times a month, when Mrs. Uphus took the day-care children on field trips, i.e., to the library, zoo, and grocery store, the garage was used to access her car. During the winter, the Uphuses used the snowblower to dear their home entrance for the day-care children, and in the summer and spring, the Uphuses used the lawn-care materials to maintain the yard. Often, Mrs. Uphus used the tools in the garage to fix the bikes or other play items.

"The Walker garage was rarely used in the day-care business. The children were prohibited from playing in the garage. The Walker garage generally contained Mrs. Walker's car and miscellaneous personal items of the Walkers. Mr. Walker's car was parked on the street. On occasion, one of the day-care children would leave a bicycle in the garage during the day. A few times a week, Mrs. Walker used the garage to access her car when she took the children on field trips, usually to the library, park, or zoo. Four days a week, the day-care children used the garage to access Mrs. Walker's car because she took the day-care children with her when she drove her child to preschool."  When we compare the facts of our case with the facts of these cases we can clearly see that Mrs. Rosales' use of her garage is close to the Uphus case and thus she is entitled to count the square feet of the garage as regular use in her business.

Taxpayer's main bedroom and bathroom

Taxpayer contends that this room is regularly used in her business based on the following facts: State licensing rules requires her to have an answering machine that is located in this room. Taxpayer checked for messages several times a day. She stored two marionette puppets under the bed and an oversized puppet on the headboard. These items were taken out of this room and used with the children once a week and then returned to the room. She used a vanity desk and chair in this room to do record keeping on a regular basis (at least once a week). She stores two file boxes that contain current children's files as well necessary paperwork (including business receipts) for her business. At least once each month she conducted specific paperwork in this room for the Food Program and Head Start in which she participated. She used this room as a sick room for children where they would be kept until the parent arrived to pick up the child. This occurred approximately four times a year. The room contained a sewing machine and sewing materials that the taxpayer used every few months for craft projects for her business. The bedroom's bathroom contained first aid items, a scale and thermometer that were all used in the business. This bathroom was used by the day care children at least once a day. The only way to enter the bathroom is through the bedroom.

Daughter's bedroom

Taxpayer contends that this room is regularly used in her business based on the following facts: Taxpayer was in this room several times a day. This room was used for storage of two children's folding tables that were used approximately once a month for parent/child functions and when table space was needed outside of the regular classroom. The room also contains a three-foot shelf in the closet where the taxpayer stored art supplies, construction paper, beads, cutting magazines and a paper shredder. Taxpayer also entered the room on a daily basis to get a dust buster that was plugged into the wall of this room and was used by the children to clean up.

Discussion of Regular Use of Bedrooms

IRS Revenue Ruling 92-3 grew out of an audit of a Minnesota family child care provider. The rulings says, "If a room is available for day care use throughout each business day and is regularly used as part of A's routine provision of day care (including a bathroom an eating area for meals, or a bedroom used for naps), the square footage of that room will be considered as used for day care throughout each business day. A day care provider is not required to keep records of the specific hours of usage of such a room during business hours. Also, the occasional non-use of such a room for a business day will not disqualify the room from being considered regularly used. However, the occasional use of a room that is ordinarily not available as part of the routine provision of day care (e.g., a bedroom ordinarily restricted from day care use but used occasionally for naps) will not be considered as used for day care throughout each business day."

In the Uphus and Walker cases the court distinguished between a room that is used on a regular basis and one that is used only occasionally for business purposes: "we have found that the regular basis test is met where the taxpayer is able to establish that the business use is continuous, ongoing, or recurring." The court cited the Frankel case (82 T.C. 318, 325 (1984)) in which an editor was allowed to count an office as regular use when he had on average one business phone conversation per night.

In our case both bedrooms were used on a continuous, ongoing, and recurring basis. The rooms were available for day care use throughout each business day and were regularly used as part of Mrs. Rosales' business. Again, there is no requirement that day care children play in a room for it to be considered regular use in the business.

Time

IRS Position Taxpayer Position
Hours spent caring for children	2,541	2,541
Hours spent on business activities after day care children were gone	1,144	306
Total hours	3,685	2,847

On appeal, the Appeals Officer did allow 3,220.75 hours.

Family child care providers are entitled to count all hours spent in their home on business activities as part of the calculation of the home office deduction.

IRS Revenue Ruling 92-3 says that the calculation for the time percent is based on "...the total hours in the year that the day care business is operated (including substantiated preparation and clean-up time), divided by the total number of hours in a year."

The IRS MSSP Child Care Providers Guide (TPDS No. 85187M) says, "Hours spent cooking, cleaning, and preparing activities for the business of child care could be included in the calculation of the Time-Space percentage... As with any business use of a home, care providers must substantiate claims for hours expended in the conduct of the business of providing child care."

In the Neilson v. Commissioner case (94 Tax Court, January 2, 1990) the court allowed a family child care provider in Minnesota to claim 15 additional business hours each week spent in preparation and cleaning activities when the day care children were not present in the home.

A study from the Wheelock College Family Child Care Project surveyed full-time providers in three states and found that they spent an average of 13.9 hours per week on business activities in the home after the children were gone (Economics of Family Child Care Study by Kathy Modigliani, Wheelock College, and Suzanne W. Helburn, John R. Morris and Mary L Colkin, University of Colorado, Denver).
Taxpayer kept daily records substantiating all of her business activities after the day care children were gone for the day. These records were made contemporaneously on a calendar (see attached). All of the activities shown on her calendar would not have been done except for the fact that she ran a family child care business. The IRS examiner refers to taxpayer's calendar as "unrealistic" because she worked 7 hours in April on laundry as well as another 4 hours on business activities that day. In fact, the examiner misread the calendar notation. Taxpayer claimed one (not seven) hours of laundry work that day. The day was April 7th and the examiner misread April 7 as 7 hours of laundry work. The IRS examiner also questioned time in April where the provider made a notation "unpack." This was time spent unpacking all of the materials she purchased at a state wide Association for the Education of Young Children conference in Des Moines, Iowa. She spent time putting the materials away in her garage and basement.

Attached is taxpayer's calendar showing the hours that Mrs. Rosales worked. The hours that the IRS hearing examiner did not allow are circled on the calendar. Some of the hours that the examiner disallowed were hours spent on laundry. The court in the Uphus and Walker cases specifically cited the use of a laundry room as a common activity in day care that allowed their basement areas to be counted as regular use. Certainly time spent on laundry for her 8 day care children is a reasonable business activity.

Mrs. Rosales also spent some time studying (including reading and computer time) for her classes to obtain her Early Childhood Degree. Although she did not attempt to deduct the cost of getting her Early Childhood degree (because this was her first post secondary degree) we believe she is entitled to claim the hours spent in her home studying for this degree. IRC section 280A does not say that hours spent on such classes cannot be claimed by a family child care provider in her home office calculation. These hours were spent learning skills that were then immediately applied to her business. The fact that the cost of the class was not deductible does not change the fact that the time spent on this activity was a business activity.

Home Office Calculation

Because taxpayer has a room that is used exclusively for her business we must follow the special instructions to calculate the home office deduction that is found in the instructions to Form 8829. Based on these instructions and the above facts, taxpayer is entitled to a home office deduction of 45.5%.

Exclusive use room

220 square feet / 3,591 total square feet = 6.1%

Rest of home

3,371 square feet regularly used in business / 3,591 total square feet = 93.9% Space

3,685 hours spent in the home for business / 8,760 total hours in the year = 42% Time

93.9% Space x 42% Time = 39.4%

39.4% plus 6.1% = 45.5%

Class hours represent 2.6%. (226 hours)

Interest Expense

2001

Taxpayer position: $809

IRS position: $612

2002

Taxpayer position: $906

IRS position: $581

The IRS allowed an interest deduction on the van ($612 in 2001 and $581 in 2002). They disallowed all other credit card interest as personal. Taxpayer had a separate business credit card where she purchased items for her business. See the attachment for records of these credit card purchases. We have also enclosed statements from her personal credit card so you can see that her business credit card was indeed used for business items.

This other interest was for the following purchases that were used in the taxpayer's business.

Supplies

2002

Taxpayer position: $10,231

IRS position: $6,833

Employee Benefit Program

See discussion above for Health Insurance Deduction (#1).

Accuracy Related Penalty

An accuracy related penalty is warranted when a taxpayer is negligent or intentionally disregards the rules and regulations when the taxpayer cannot establish that the underpayment of tax was due to reasonable cause. The taxpayer has shown reasonable cause for all of the above disputed items. The taxpayer relied on the professional advice of her tax preparer and there is no evidence that she intentionally disregarded any rules or regulations. There is no evidence of any connection between Mrs. Rosales and the Renaissance program that her tax advisor was involved in. 

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