The details that follow may seem overwhelming, but the message is that tax records are serious business, as one provider discovered. She was giving wonderful care, but lacked an understanding of written records and was audited by the IRS. The audit proved to be a costly learning experience for her. Unfortunately, once you are audited, it is often repeated the next several years.
Over and over, providers report that having professionals help with their taxes has saved them money. One reported a $700 savings the first year she hired a tax accountant. Understanding tax regulations is not something you can learn once and be done with. Keeping abreast of annual changes takes time and patience. The majority of providers feel their time spent keeping accurate records pays off, but the actual tax preparation is best handled by a specialist. This leaves more time and energy to do what you do best-give loving, quality time to your day care children and your own family.
TAXES AND RECORD KEEPTING
When you are paid to take care of children in your home on a regular basis, you are operating a small business. Therefore, you are legally required to file tax forms. This means keeping good records, which is often the biggest complaint of and problem for providers. The time to begin record keeping is when your new day care business is stated, or even before, as you begin to collect materials and make renovations!
The garage sale purchases and many other items you buy can be forgotten between the time a business opens and "tax time." This means you will be cheating yourself on your taxes. Listing all the expenses of running your day care business is a big part of keeping accurate records. If you write down every expense or deduction, you can legally keep your taxes down.
DIRECT DEDUCTIBLE DAY CARE EXPENSES
Some deductible expenses will be one-time costs only (items like a fire extinguisher and bulletins boards, for example). Others are yearly expenses, like payment of your liability insurance. But most items are ongoing costs (food, field trips) that will appear on your monthly records of expenses. Generally, the following expenses are deductible. It is important to obtain updated information on a yearly basis.
INDIRECT BUSINESS EXPENSES
These are expenses shared between your family and your day care business. Only a percentage of these costs are allowable deductions. Record the costs and then determine partial deductions. Use the space-time formula to figure the portion of these expenses that you can deduct.
Space-time percentage, a formula used to figure how much of an item is shared between your business and your family, can be used for deductions. Here's how it works.
Use this percentage to figure how much you can deduct from all shared expenses, such as utilities. For example, if your electric bill is $100 for March, multiply that by 22.3 percent. You get $22.30, which is the amount that you can deduct for that month for an indirect business expense.
Multiply this time-space figure by the cost of items used for both your business and your family. Then use the total as your business deduction under part 11 of schedule C on your return. (See "Schedule C Form 1040" in the IRS Forms Section in this fact sheet.)
While running your family day care home, you may buy several large items that can be depreciated. These are items like a swing set or refrigerator, which generally cost over $100 and are not used up in the year that they were bought. To figure depreciation, you will have to know whether the IRS considers the item a three-year, five-year or 10-year property. Typically, items bought for family day care are considered 10-year properties. But because of changes in the tax law, you need to consult the IRS or your tax advisor for specific information about depreciation.
If you share an item with your family you can claim only a portion of depreciation for each year. A refrigerator, for example, is something you use for both your family and your business. Likewise, if you buy a swing set and have children of your own, you can claim only a portion of the swing set's cost because your children also use it. On the other hand, if you can prove that you would not have bought this item except for your business and it's required for registration or safety, you can claim the entire amount of the yearly depreciation.
If you share items with your family, use the yearly depreciation and multiply it by the percentage you obtain from the time-space formula described in this part. If you bought a new refrigerator, you can deduct only a portion of the depreciation. If, for instance, the first-year depreciation on a $1,500 refrigerator is $120, the portion of depreciation you clain would be $120 times 22.3 percent (or your exact percentage) for a total of $26.76. In other words, you can deduct $26.76 as depreciation on your refrigerator the first year. Claiming all legal deductions certainly will help lower your taxes.
IRS FORMS, DESCRIPTIONS AND HELPFUL PUBLICATIONS
Family day care providers who net $400 or more a year are required by law to report their earned income to the Internal Revenue Service, whether they are required to file a return or not. A provider who does not report income could face charges of defrauding the federal government.
In reporting your income, you will need several forms from the IRS. Be sure that each has the correct year (the year in which you are reporting the income) at the top. Copies are available at the Internal Revenue Service, local post office and other municipal buildings.
The first form is Schedule C Form 1040, Profit or Loss from Business or Profession. This form shows how much money you earned during the year from your day care business, what your expenses were and what your net income or loss was.
Monies received through the Child Care Food Program(CCFP) must be recorded as income. Put this amount on Line 4B, "Other Income" on the Schedule C form. Food that you have purchased with CCFP money should be recorded as a business expense and listed as a deduction on line 31, "Other Expenses" on Schedule C.
Several IRS publications are helpful for filling out Schedule C and are available if requested. One of them is Tax Guide for Small Business, publication #334, a booklet that explains some of the Federal small business tax laws. Another important publication to have is Business Use of Your Home, publication #587. It helps you decide if you qualify for certain deductions, such as business use on a home computer and video player. Check the rules related to "listed property."
A third publication that is important is Information for Business Tax Payers, publication #583. This booklet gives sample small business records, shows how to prepare complete and accurate tax returns and how to be certain you pay only the tax you owe.
SCHEDULE SE, FORM 1040 SOCIAL SECURITY SELF-EMPLOYMENT TAX
Since you do not have an employer to take out social security payments from your paycheck, you have to do this yourself--if your business earnings are $400 or more each year. As a self-employed person, you pay your social security tax in the form of a self-employment tax, using a special form known as Schedule SE, Form 1040. For 1990, the net tax rate for self-employment is 15.032. This current rate appears on Schedule SE. Figure your tax, using the following steps:
The IRS publication #533, Self Employment Tax, explains the self-employment tax, which is really social security for people who work by themselves. This would be a help in filling out Schedule SE, Form 1040.
Form W-2, a wage statement, should be completed by individuals who perform services for your child care program. These forms are issued both to the employees and to the IRS each year. Form #941, Employees Quarterly Federal Tax Return, has quarterly returns that are also prepared for these workers.
Form #940 is an annual report necessary to report federal unemployment tax. You must withhold income from employees' wages based on withholding allowances they claim on their W-4 forms. You can find the correct amounts to withhold from the chart contained in publication #15, Circular E, Employers Tax Guide available from IRS.
Remember, a state could also require a state Withholding Form and a state Unemployment Form, so check with your state tax agency or tax expert.
Some people prefer paying assistants and helpers "under the table." This should be avoided since heavy penalties may result if IRS or the State Unemployment Commission determines that an employee-employer relationship exists. Check with the proper taxing authorities for exact information.
Another form you will need is 1040 ES, Estimated Tax for Individuals, if you think the total of your estimated income tax and self-employment tax for the year will exceed your total withholding and credit by $500, or if you generally get a refund. This form must be filed quarterly, so it contains four payment vouchers for you to tear off and use.
You will need to fill out a form called Depreciation Form, #4562. Use this form to record your annual depreciation of capital expenditures related to your business. Any equipment, including toys and play equipment, expected to have a useful life of more than one year should be considered fordepreciation. Again, you may need to consult with a tax specialist regarding the proper categories
IRS publications that may be helpful include publication #534, Depreciation, a discussion of various methods of depreciation including modified, accelerated, cost recovery systems. Another is publication #535, Business Expenses, which contains information about business expenses paid to employees, such as fringe benefits, insurance, employee benefit plans and certain educational expenses.
Finally, publication #917, Business Use Of Your Car, explains expenses and the new rules for deducting expenses for the business use of your car.
In Part #4, you read about the 1993 deductions of 28 cents3 per mile for all miles driven on day care business. This 28 cent figure should be multiplied by the number of day care business miles driven during the year. Total figures should be recorded on your mileage charts and then multiplied by 28 cents, giving your deduction for mileage expenses. If you choose to use Form #2106 to figure your actual auto expenses (rather than taking the standard mileage rate), you must do detailed records of all car expenses. Reading IRS publication #917, Business Use of Your Car, is helpful in preparing your return.
Finally, long form Form 1040, Individual Income Tax Return Long Form, ties both your personal and business incomes and deductions together and determines the amount of taxes you owe, or the amount of your refund. If you are married, you may wish to file a joint return, which usually means a lower tax, and figure your tax with your spouse. However, with the change in the tax laws you will want to obtain professional advice on tax matters. Be sure to ask for instructions for preparing Form 1040 from the IRS. The publication #17, Your Federal Income Tax can also help you prepare your return. It takes you through the return step-by-step and explains the tax laws that cover salaries, wages, interest, dividends and itemized deductions.
A FINAL CONCERN
Most of the income that you receive from your family day care business will show up on other people's tax returns. Parents use these figures to determine their allowable Child Care Credits. This may make your income very visible to the Internal Revenue Service more so than other types of income. Therefore, you should be especially careful to report all receipts from your business. Accurate records are vitally important.
HOW LONG TO KEEP RECORDS
The question of how long to save your tax returns and business records always seem to come up. It is also true that each person you ask will give you a different answer. The IRS recommends that you keep your personal tax records for at least three years. Your business records, and particularly those of employees, should be kept for four years. If you are depreciating your house, you need to keep those records for at least three years after the sale of your house. As a rule, save all business records for seven years.
WHAT HELP IS AVAILABLE
The Internal Revenue Service provides a small business tax workshop designed to help small business owners, like family day care operators. These sessions typically include:
Workshops are ongoing. You can call toll-free 1-800-829-1040 to ask for information and a workshop registration form. The IRS maintains a tax information service with a toll-free number that answers your questions about federal income tax. That toll free number is 1-800-424-1040. You will find more information numbers in your telephone directory under United States Government Internal Revenue Service. To order tax forms or publications, the toll free number is 1-800-828-3676. (See Resources Section.)
The Internal Revenue Service has Tele-Tax tapes that cover 150 different topics. This is fast tax action by phone, at 1-800-829-4477. To receive a listing of tape topics, and numbers request publication #910, Guide to Free Tax Services.
Many people enjoy working with figures and find doing their records and tax accounts extremely satisfying. For other people, simple bookkeeping is work enough, and they have someone trained in tax preparation to complete and file forms. If you are hiring others to help you prepare your taxes, be sure to ask about their small business training. More importantly, does the tax preparer have experience preparing family day care tax returns?
Ask other providers who prepare their taxes. Often the tax person who has specialized in small businesses and worked with family day care providers knows a great deal, which may be helpful for you in tackling your own tax returns. But whether you prepare your tax returns yourself or seek outside help, you will gain the most if your records are complete, accurate and ongoing.
This is subject to change each year. Check with your tax accountant.
Source: Family Day Care Bulletin #4020, University of Maine. Original author Jane S. Harvey former State Coordinator of Child Care, University of Maine Cooperative Extension. This series was revised and reprinted in 1994.