Family Child Care Provider Saves $840 in IRS Audit

"I think every daycare provider's worst nightmare is being audited by the IRS," a family child care provider from Woodbury, Minnesota wrote to me recently.

When she received her IRS audit notice last July she had just been through a rough few years. Both of her parents died and she had to move out of her foreclosed home right before last Christmas. "Needless to say, my daycare records were not kept to the best of my ability," she said.

Her auditor would not count the hours she worked on business activities in her home when daycare children were not present. He also disallowed hundreds of dollars she spent on presents for the daycare children and denied her deductions for the water, sewer and gas/electric house expenses.

After she contacted me for assistance, I helped her draft a letter to the auditor which successfully led to him changing his mind and reducing her tax burden by $840!

Time-Space Percentage

Like most child care providers, she did not keep good records of the number of hours she worked in her home on business activities when children were not present. On her tax return she had estimated that she worked 55 minutes in the morning before children arrived (preparing breakfast and cleaning up) and 90 minutes in the evening after the children left.

I asked her to keep a daily record and, after a week, she presented this to the auditor. Her records showed that her typical evening work included: "Pickup toys, sanitize bottles/toys, vacuum clean entire house, sweep and mop kitchen floor, empty and fill dishwasher, laundry, bookkeeping, preparation of preschool crafts - gathering supplies (glue, construction paper, sequins, scissors), clean bathrooms (toilets and floors)."

The auditor was originally only going to allow her to count an extra half hour a day, but changed his mind after looking at her reconstructed records.

My advice has always been for child care providers to track these hours for at least two months each year. I cannot emphasize how important it is to follow my advice and track these hours for two months each year. In this case, we won without such records, but there is no guarantee that you will. Typically child care providers underestimated these hours.

Gifts

She had claimed $1,790 in gifts to the children over two years. The auditor applied a "gift" rule that says you can only claim up to $25 per person, per year as a business deduction. I pointed out that the IRS Child Care Audit Technique Guide makes a distinction between gifts and children’s activities: “Examiners should not confuse expenses related to activities done withthe children with gifts.”

I had her explain to the auditor that the children opened their present and played with the items with the other children in her program.

If you identify expenses as "gifts" on your tax return, expect the IRS to try to apply this $25 rule. Instead, list them as activity expenses if they are items that are shared with the other children in care.

Utilities

For reasons we don't know, the auditor originally disallowed her expenses for water, sewer, and her monthly energy bill from Xcel Energy. When we pointed out that she was allowed the time-space percentage of these expenses on IRS Form 8829, the auditor agreed.

After the audit was over, she wrote me, "I was very pleased and I know I couldn't have done it without Tom's help."

Tom Copeland - www.tomcopelandblog.com

Image credit: https://pixabay.com/photos/woman-smile-happy-happiness-joy-5480503/

For more information about how to keep accurate records and improve the chances that you will not owe any money if you are audit, see my Family Child Care Record Keeping Guide.