While mostly associated with aiding the tax preparation process (federal, state, local), income/expense tracking and record keeping also allows a provider to be in compliance with legal requirements (such as employee records), to see the progress of his/her business, and to plan the business’ future.
Regardless of a childcare provider’s business structure, it is extremely important and helpful that he/she keep a record of all income and expenses, retain all receipts, and distinguish between personal, business, and what is shared. As a family childcare provider, items brought that are used for both business and personal purposes probably represent the vast majority of the purchases.
Receipts and/or other records (i.e. bank statements, canceled checks, credit card statements, attendance records, meal logs, calendar notations, ledger, digital files/spreadsheets, mileage logs, photographs, etc.) are needed to justify the data presented in the provider’s tax forms.
Before putting away receipts, the provider mark which items were used exclusively for his/her business, personal or were shared. Receipts should be stored in folders or envelopes containing similar expenses (toys, supplies, utilities, household items, etc.). A place should e set up in the home where receipts can be placed and organized.
Review your records at least once a month.
The IRS recommends maintaining records for 3 years; however, the IRS can audit for periods more than 3 years past. Employee record keeping rules vary according to federal and state government requirements and it’s just as important to regularly destroy and dispose of unnecessary records.
In addition to keeping a record of income and expenses, a provider should also document working hours. This is an important step in calculating the amount of rent/mortgage and other household expenses that a provider may be able to deduct on Schedule C as a sole proprietor. He/she may do this by keeping a separate log, a recording on an attendance sheet, or on a calendar.
Note: working hours are not solely the hours’ children were in the provider home, but also time spent cleaning, doing laundry, meal preparation, planning/preparing activities, interviewing parents, paperwork, writing emails, taking business calls, doing recordkeeping, and more.
The high level of shared household and business expenses presents a special challenge for family child care providers.
As a sole proprietor, a childcare provider is not required to have separate accounts for personal and business. A childcare provider is required to maintain accurate record keeping. Having separate personal and business accounts are deemed to be the most practical way of achieving this. For this reason, it is recommended that the provider establish checking and credit card accounts specifically for the business.
If the provider is a sole proprietor or partner, he/she can take a draw by writing a check to himself/herself from the business account.
Separate accounts may also reduce accounting/tax preparation expenses since the accountant/preparer will not need to spend time separating personal from business.
Should the provider be audited, keeping personal and business separate will provide a clearer audit trail.
The IRS in its Child Care Provider Audit Technique Guide has stated; “examination of these returns may result in the following determinations:
- Income is frequently understated and may be paid in cash;
- Expenses are often overstated and may be paid in cash;
- Record keeping is often inadequate;
- Issues most often adjusted include:
- Gross receipts,
- Food reimbursement,
- Food expense (may include personal expenses),
- Business use of home,
- Unusually large expenses, and
- Supplies and miscellaneous expenses (may include personal expenses).”
Even with separate personal and business accounts a family childcare provider will have shared expenses, i.e. rent/mortgage, mortgage interest, utilities, repairs and maintenance, home depreciation, vehicle, cleaning supplies, etc. For these expenses, he/she will use Time-Space percentage to calculate the amount deductible for business purposes.
As an LLC a provider must keep business and personal records completely separate. This can be a challenge since he/she cannot write personal checks out of the business account. The provider will have to pay for household expenses (supplies, food, repairs, etc.) out of his/her personal account and reimburse the business portion out of a business account. However, the provider won’t know the business portion (your Time-Space percentage) until the end of the year.
Failing to segregate the assets of the LLC may, under certain conditions, lead to a loss of an owner’s limited liability status (aka piercing of corporate veil.)
As a home-based business, family child care service providers may be particularly challenged to demonstrate that the business is separate and apart from the owner (member.) Consequently, are more likely to have their corporate veil pierced. The most effective way to protect against this eventuality is to obtain proper insurance coverage. See here
See how to open a small business bank account
Resources and Links:
There are a number of federal and/or state requirements related to employer record There are a number of federal and/or state requirements related to employer record keeping. Generally, basic records that an employer must retain include:
- Employee’s full name and social security number;
- Address, including zipcode;
- Birth date;
- Sex and occupation;
- Time and day of the week when employee’s workweek begins;
- Hours worked each day;
- Total hours worked each workweek;
- Basis on which employee’s wages are paid (e.g., “$9 per hour”, “$440 a week”, “piecework”);
- Regular hourly pay rate;
- Total daily or weekly straight-time earnings;
- Total overtime earnings for the workweek;
- All additions to or deductions from the employee’s wages;
- Total wages paid each pay period;
- Date of payment and the pay period covered by the payment; and
- Benefits-related materials.
Under the Fair Labor Standards Act (FLSA), employers are required to keep payroll records for employees for three years.
The U.S. Equal Employment Opportunity Commission (EEOC) requires that employers maintain all employment records for one year from the employee’s termination date.
The Age Discrimination in Employment Act (ADEA), requires employers to retain payroll records for three years from the termination date. Other employee benefits information must be retained for only one year.
Should a provider have any legal disputes with an employee, he/she should retain records at a minimum until a resolution/legal decision has been reached.
New York State
A provider must keep a record of the withholding allocation used for New York State nonresident employees performing services partly in New York State, and the allocation used for Yonkers nonresident employees performing services partly in Yonkers.
Every employer or agent required to withhold state and city taxes, and every person required to file information returns must keep all records of these taxes and information returns available for review by the Tax Department. Keep these records for four years after the due date of the tax for the return period to which the records relate, or the date the tax is paid, whichever is later. Records for information returns must be kept for four years after the due date.
Provider’s should visit their state’s department of labor to learn about the record keeping requirements of their state.
Resources and links:
Often swamped with paperwork, many entrepreneurs wonder how long they should keep business records. The answer depends on a great deal upon whom they ask and what the record pertains to in the business. The IRS sets some basic record retention standards for tax records. Yet lawyers, accountants, banks and government agencies all seem to have different ideas about how long to retain business records depending upon each individual business circumstances. In our digital era, both paper and electronic documents need to be considered in the record preservation plans. Here are some basic record retention rules to think about a childcare business.
Business Income Tax Returns and Supporting Documents. It makes sense for a provider to keep a final copy of his/her business income tax returns and related correspondence with the IRS permanently to help prepare future or amended returns. The IRS recommends retaining supportive records that corroborate any business income or deductions claimed until the “period of limitations” expires for that tax return. The period of limitation is the time period from the filing date in which either the individual might seek to amend his/her return for a credit or refund or the IRS may pursue a business for additional taxes. Typically, the IRS can come after a business for failing to report income for up to 6 years after filing if the amount is greater than 25% of the business’s gross income. If an individual filed for a deduction for a bad debt or worthless security, the IRS suggests keeping supporting tax records for 7 years. Under these circumstances, a provifer may generally wish to retain supportive records for at least 7 years.
Employment Tax Records. If a provider has employees, the IRS suggests retaining all employment tax records for a minimum of 4 years after the date those taxes were due or were paid, whichever is later. These employment tax records include such items as an employer identification number, amounts, and dates of wage, annuity and pension payments and tax deposits, the names, addresses, social security numbers, dates of employment and occupations of employees and records of allocated tips and fringe benefits.
Business Asset Records. If business property is involved, the IRS recommends retaining records until the period of limitations ends from the year an individual disposed of that property. These records will aid in calculating applicable depreciation, amortization or depletion deductions and to determine any gain or loss on that property. If the business property is real estate or a vehicle, keep the deed or vehicle title in a safe, secure spot until sold or otherwise properly dispose of that property.
Business Ledgers and Other Key Documents. CPAs tend to be a conservative group and will often recommend that businesses keep their journal entries, profit and loss statements, financial statements, check registers and general business ledgers permanently. Similarly, major business documents, like annual reports, corporate by-laws and amendments, Board of Director information, annual meeting minutes and business formation documents, should also be retained on a permanent basis. Aside from supportive tax records, other documents such as accounts payable/receivable ledgers, invoices, and expense reports should be retained for a minimum of 7 years.
Human Resources Files. A provider may have numerous other employment files related to current and former employees and applicants to a business. Excluding employment tax records, files relating to current employees should be retained while they are working for the employer, and at least 7 years after a current or former employee has left or been terminated. For any job applicants who were not eventually hired, files should be kept for at least 3 years. If an employee has suffered an accident on the job, those records should be retained for at least 7 years after that matter was resolved or up to 10 years after which any workers compensation benefits were paid. If an employee lodged a discrimination claim against the business, those records should be retained for at least 4 years after the case is concluded. Records should be kept of employee benefits, pension payments or profit sharing plans, permanently.
Canceled Checks. Canceled checks without a tax or other significant business purpose can normally be destroyed after about 7 years. If a canceled check is a supporting tax document, then follow the IRS rules discussed above.
Bank Account and Credit Card Statements. Generally, bank account and credit card records should be retained for about 7 years. This retention period may be longer if they are supporting documents for tax purposes. However, if these statements have no tax or other key business purpose, then a childcare provider should consider retaining the business’s detailed annual statements for 7 years and disposing of underlying monthly statements after about a year.
There may be times when a childcare provider must suspend the usual record disposal plans, such as when litigation is likely or pending on a business matter. The provider may wish to consult with an attorney or tax professional to look into his/her individual circumstances to help guide his/her particular business regarding record keeping and disposal policies. To avoid identity theft and to protect sensitive business information, a provider must properly dispose of or shred appropriate business records. For more about tax record keeping and retention, see IRS Publication 583, Starting a Business and Keeping Records at http://www.irs.gov/pub/irs-pdf/p583.pdf.
NOLO. (n.d.). How Long Should You Keep Business Records. Retrieved from http://www.nolo.com/legal-encyclopedia/how-long-should-you-keep-business-records.html
Food is a major expense for family child care providers. Keeping track of this expense can also be a major challenge.
Receipts of food purchases are evidence that food was purchased, but how much was actually consumed by children?
Note: Only 50% of an assistant’s meal is deductible. However, providers can deduct 100% of the cost of food consumed by employees if its value can be excluded from their wages as a de minimis fringe benefit (a service provided to the employee that has such minimal value that accounting for the receipt would be unreasonable). None of what the provider and his/her family consume is deductible.
A family child care provider has the option of calculating food expense deduction using either:
- Standard Meal Allowance Method or
- Actual Food Cost Method
Standard Meal Allowance Method
To simplify record keeping requirements the IRS provides an optional standard meal and snack rates that family child care providers may use in computing the deductible cost of food provided to eligible children in the day care in lieu of actual costs.
The rate is based on the Tier I rate or the lower Tier II rate under the Child and Adult Care Food Program (CACFP). The provider may use the standard meal and snack rate for a maximum of one breakfast, one lunch, one dinner, and three snacks per eligible child per day. CACFP Reimbursement Rates
There is still a record keeping requirement, which includes the name of each eligible child, dates and hours of attendance in the family day care, and the type and quantity of meals and snacks served.
Actual Food Cost Method
Using this method involves estimating the actual cost of the food served to the children in the provider’s care. There are many different ways to do this:
- Buy business and personal food separately;
- Estimate the provider’s own average cost per meal and multiply by the number of meals served;
- Calculate the percentage of the provider’s total food bill that is for his/her business; and
- Calculate an average weekly cost of business food
A provider must keep receipts for all food purchases! This includes business food as well as personal food. All receipts must be saved when the provider’s family eats out on the weekend or when his/her child/spouse buys lunch during a workday. The provider should label all receipt items as either business, personal or shared. Aside from business and personal food receipts, a provider must keep the following records: menus, name of each child, dates of attendance, and the number of meals and snacks served.
What Line of Schedule C
Childcare providers deduct the cost of food in several different places on their returns including, but not limited to, the “Cost of Goods Sold” line, the “Supplies” line, or the “Other Expenses” line. IRS Publication 587 uses “Other Expenses” line in its food related examples
Food Program Reimbursements (Child and Adult Care Food Program/CACFP)
The United State Department of Agriculture provides reimbursement to childcare providers through the Child and Adult Care Food Program (CACFP). The United States Department of Agriculture (USDA) administers the CACFP through grants to states. The actual agency involved can vary by state. Independent centers and sponsoring organizations can enter into agreements with individual states to administer the program.
A child care provider must sign an agreement with the state or sponsoring organization to participate in the CACFP. The provider must be licensed or approved to provide day care services in order to participate.
Reimbursement for meals served in child care homes is based upon eligibility for Tier I rates (which targets higher levels of reimbursement to low-income areas, providers, or children) or the lower Tier II rates.
Program payments for child care homes are based on the number of meals served to enrolled children, multiplied by the appropriate reimbursement rate for each breakfast, lunch, supper, or snack they are approved to serve. Reports showing the meals provided to the children are submitted to the administering agency and can be one of the tools an IRS examiner may use in verifying income as part of an audit.
How to Report Food Reimbursement Payments
Food reimbursement payments are sometimes reported on Form 1099. If a provider received Form 1099, the provider can report those payments under the “Other Income” section of Schedule C by writing in “CACFP Income.” If no 1099 is received, the provider can report payments under other income or as an alternative method net the payments against the food expense.
The recommended method (per the Child Care Provider Audit Technique Guide) is to report all the reimbursements under the income section of Part I of the Schedule C and then deduct the food expenses in full or use the standard meal allowance.
Note: A provider is entitled to deduct meals or snacks not reimbursed by the food program (i.e. cake, chips, popsicles). While CACFP reimbursements are reportable income, a provider is better off participating in a food program than not. Learn more here.
Resources and Links:
A great number of items, assets and/or services a family childcare provider uses have a personal as well as business component (i.e. are shared expenses). The business portion of the costs/expenses associated with these is deductible. The business portion, generally, is determined by the provider’s time-space percentage.
Legal & Professional Services
Costs related to tax preparation of business tax forms are deductible. A provider should have a tax preparer separate the costs of business and personal tax preparation fees. He/she may deduct the cost of tax preparation of personal forms on Schedule A (if the provider itemizes personal deductions.).
Bank Charges: Business account costs are 100% deductible. For example, if a provider writes business checks from a personal checking account, then a percentage of the costs are deductible. In this case the deduction is based on the percentage of checks written for business purposes.
Books & Magazines: Childcare-related books/magazines are 100% deductible; deductibility of other books depends on whether the provider has children who may also use these books/magazines.
Computer & Related Supplies
Deductible items include: computer, disks, printer cartridges, software, etc.
Stationary is deductible including: papers, envelopes, notebooks/pads, postage, etc
Supplies are tax deductible. These include: bulletin boards, business forms, calculators, calendars, file holders, ledgers, pencils/pens, receipt books, staplers/staple removers, etc.
Rent of Business Property
If a provider or his/her family member uses any of the items after hours that are rented or claimed in the time-space percentage of the cost as part of the business, the provider can still justifiably deduct the full amount.
Repairs & Maintenance of Personal Property
Repairs are deductible depending on the cause of damage. For example, property damage caused during business use is fully deductible, while deductibility of property damage caused during personal use is limited to time-space percentage). Maintenance encompasses a wide variety of items such as: air freshener, baby wipes, batteries, bleach/cleaning liquids, broom, buckets, candles, cleansers, clothespins, detergent/softener, dust buster, flashlight, garden hose, gas for lawn mower, hamper, hoe, iron, laundry service, lawn mower, lawn sprinkler, mop, paper towels, pest control, polish, rake, sand box/sand, service contracts on appliances, shovel, sponges, tissue, toothbrush/toothpaste, towels, vacuum cleaner/bags, wastebasket, wheelbarrow, window shades, work/gardening gloves, etc.
Children’s supplies are tax deductible. These include: art and crafts supplies (brushes, clay, construction paper, crayons, glue/paste, markers, paint, scissors, stencils, stickers, etc.), backpacks, baby intercom system, baby swing, balls, bibs, blocks, board games, booster seat, chalk/chalkboard, changing pad, children’s furniture, cots, crib/mattress, dolls, dress-up clothes, easel, floor mat, high-chairs, infant seat, jump ropes, magnifying glass, mirrors, mobiles, pegboards, plastic crates, playpens, playground equipment, potty seat, presents purchased for the provider’s children but used by the children in the his/her care, puppets, puzzles, rattles, riding toys, sand and water table, skates/skateboard, smock, stuffed animals, thermometers, tissue paper, walkers, wagons, water toys, wind chimes, and yarn.
Other deductible household items include: bicycles, bins/storage containers, camera, car seat, clock, extension cord, fire extinguisher, first aid kit, flowers/flowerpots, gates/safety barriers, light bulb, linens, safety caps for outlets, safety locks, scale, shelving, smoke detector, tools (hammer, nails, screw driver, ladder, etc.), umbrella, and more.
Deductible kitchen supplies include: aluminum foil, bake pans/dishes, blender, bowls, can opener, cookie cutters, cups, cutting board, dish towels, dishes, disposable plats/cups, food processor, garbage bags, garbage can, knives, matches, measuring cups/spoons, mixer, napkins, plastic ware, plastic wrap, potholders, pots/pans, silverware, tablecloth, timer, and more.
Business Use of Home
A provider can calculate the business use of home expenses on Form 8829. Learn more here.
Note: The degree to which any of these items, assets and/or services is deductible depends on each provider’s specific circumstance. A provider should take into account whether he/she and family members use any of the aforementioned for personal use? What is the time-space percentage?
Childcare providers are allowed a deduction for expenses associated with business use of their homes. The requirements for the deduction are different than those for other businesses since qualifying usage does not require exclusive use for business. Regular usage is generally qualifying. A provider may have a combination of exclusively used and regular used rooms, which is discussed in the instructions for Form 8829.
If the childcare provider meets the requirements for the deduction, then this is computed on Form 8829, “Expenses for Business Use of Your Home.”
In order to qualify for a business use of home deduction, a provider must be in the trade or business of providing day care for children, and have applied for, been granted, or be exempt from having, a license, certification, registration, or approval as a day care center or as a family or group day care home under state law. The provider does not meet this requirement if his/her application was rejected, or the license or other authorization was revoked.
Note: The licensing requirement applies only to the deduction for business use of the home. An unlicensed provider may still deduct other business expenses, such as food, toys, supplies, etc.
Regular Usage of a Room Defined
In determining whether a space in the home passes the “regular use” test in computing business use of a home, Revenue Ruling 92-3 outlines the following:
“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.”
Business Use of Home Deductions
Home use related expenses that may be business deductions include:
- Casualty losses
- Deductible mortgage interest
- Real estate taxes
- Excess mortgage interest
- House insurance
- House rent
- Repairs and maintenance
- Land improvement
- Depreciation of the home
The extent to which the above are deductible is dependent on a provider’s business percentage – the business portion of these shared items.
Determining Business Percentage
A business percentage consists of two elements: space percentage and time percentage, as discussed. The two percentages are multiplied by each other to get the business percentage. See Time-Space Percentage.
Note: Since the requirements for the business use of a home deduction are different for family childcare providers than those of other businesses, for tax purposes it is important that a provider work with an accountant/tax preparer who is familiar with these differences. See “The Unique Tax Rules Affecting Family Child Care.”
Resources and Links:
- Form 8829, Expenses for Business Use of Your Home
- Child Care Provider Audit Technique Guide
- Child Care Provider Audit Technique Guide
A childcare provider needs a telephone in order to operate his/her business. Therefore, a telephone is deductible as an “ordinary and necessary” business expense.
IRS rules clearly state: “The cost of basic local telephone service (including any taxes) for the first telephone line you have in your home, even though you have an office in your home is not deductible.” (See IRS Publication 535 Business Expenses)
There was a time when the first telephone line was tax deductible, but Congress passed a law in 1988 taking away this deduction.
Some childcare providers have argued that since childcare licensing rules require that they have a telephone, their telephone bill should be deductible. Although childcare providers are required to have a telephone line to become licensed, the IRS clearly states that this cannot be deducted.
The first phone line into a provider’s home, whether it’s a landline or a cell phone, is not deductible. A provider can, however, deduct the business portion of expenses associated with this first phone (i.e. business long distance calls, caller id, an answering machine, and the cost of the phone).
Second phone line
If a provider has a second (or third) phone line into the home, he/she can deduct the business portion of these lines. The phone lines can be landlines or cell phones.
If a second phone line is used exclusively for the business, then the provider can deduct 100% of the cost. If the provider uses it for business and personal purposes, he/she can use Time-Space Percentage to determine the business portion. Actually, a more accurate measure of the business use of the second phone line might be the Time Percent.
Note: Under an old law, taxpayers had to track the actual use of their business telephones. But, this requirement was eliminated under the Small Business Jobs Act of 2010.
If a provider’s telephone, Internet, and cable television bill is bundled together in one bill, how does he/she break out the cost of the second telephone line?
If a cable company won’t break out the cost of the telephone lines, the provider should do the following:
- Divide the total bill by three;
- Divide the third of the bill that represents the telephone lines by the number of phone lines;
- Deduct the business portion of the second or third line used for the business; and
- If the bill tracks the minutes used on each phone line, determine the business use based on the percentage of business minutes used.
Source: Copeland, T. (2015, October 19). Is Your Telephone Bill Deductible. Tom Copeland Blog. Retrieved from http://tomcopelandblog.com/is-your-telephone-bill-tax-deductible
Resources and Links:
How much of a tax professional’s bill can be deducted as a business expense after filing taxes?
- All of it
- Part of it
- None of it
The correct answer is 2) Part of it.
A provider can deduct as a business expense the cost to file business tax forms on Schedule C. The cost to file personal tax forms can be deducted on Schedule A.
A tax professional should break out the tax preparation fee into two parts: the fee to prepare business tax forms and the fee to prepare personal tax forms.
Therefore, ask your tax professional to break out your tax preparation fee into two parts: the fee to prepare your business tax forms and the fee to prepare your personal tax forms.
A provider should report the cost of filling out business tax forms on IRS Schedule C, line 17 (Legal & Professional Services). The business tax forms include: Schedule C, Form 4562 Depreciation and Amortization, Form 8829 Expenses for Business Use of Your Home, and Form 1040SE Self Employment Tax.
A tax professional may have filed other business forms for the provider for property sold (including the provider’s home), employees hired (payroll tax forms), amended tax return (Form 1040X), or recaptured previously unclaimed depreciation (Form 3115). If so, the provider should include the cost to prepare these additional tax forms as a business expense.
The provider’s personal tax forms would include Form 1040 U.S Individual Income Tax Return, Schedule A Itemized Deductions, and all other forms not directly related to the business. The fee to fill out these personal tax forms can be deducted as a miscellaneous itemized expense on Schedule A.
When to Deduct Fees
Since a provider paid a tax professional in 2014 to do a 2013 tax return, he/she must claim this expense on the 2014 tax return. For the 2013 tax return, the provider can deduct amounts paid in 2013 to have 2012 taxes done.
Copeland, T. (2014, January 31). How to Deduct Your Tax Preparer Fees. Tom Copeland Blog. Retrieved from http://tomcopelandblog.com/how-to-deduct-your-tax-preparer-fees