IRS Tax Court Accepts 98% Time-Space Percentage!
"I was so relieved, I broke down in tears," said Maryland family child care provider Cathy Ross when she heard the news that the IRS Tax Court had accepted her 98% Time-Space Percentage.
"This has been such a weight on me. I still tremble when I realize that this is finally over and that we won!"
This case represents the highest Time-Space Percentage I've ever seen accepted by the IRS in my thirty-year involvement representing family child care providers in IRS audits. In a 2013 Tax Court case I won a 93% Time-Space Percentage.
As a result of this victory, Cathy saved about $9,500 in taxes.
Because of her experience, Cathy came up with a number of recommendations for other child care providers who are audited by the IRS. See a separate article about this.
Cathy cared for 13-17 full and part-time children in 2009 and 2010. At least one child was present in her home 24 hours a day, 7 days a week, 51 weeks a year. She had help from her husband and daughters!
In 2012 the IRS notified Cathy that she was being audited her for 2009 and 2010. The original auditor said that family child care providers could never claim more than a 50% Time-Space Percentage.
As a member of the National Association for Family Child Care, Cathy asked for my help. I drafted letters for her to send to her auditor, citing IRS documents that supported her position.
Hearing Officer Creates His Own Formula
After Cathy was unable to convince the auditor's supervisor, we decided to appeal her case to an IRS hearing officer. The hearing officer told her that he would accept a 56% Time-Space Percentage, but not higher.
He based his opinion on a complicated formula that he created on how to calculate her Time-Space Percentage. His formula looked at how many hours each day children were in her home and multiplied it by the percentage of space they were using while in the home.
For example, when full-time children were present for 12 hours a day and were using all the rooms in the home, this was equal to 36% use of the home. When only one child was present in the home for nine hours overnight and only used one bedroom, this added another 1% to the total. When another child was present for 11 hours on Saturday and Sunday he assumed they only used 50% of the space in the home, so this added another 7% to the total. And so on to reach his 56% total.
This approach to the Time-Space Percentage was unique, but wrong!
I wrote a lengthy reply to the hearing officer, citing numerous IRS written authorities that contradicted his formula, but he wouldn't reconsider.
This left us no choice but to exercise our final appeal and go to U.S. Tax Court.
I wrote a letter to the Tax Court lawyer documenting why Cathy's position was correct.The Tax Court lawyer accepted our argument without discussion and her case was settled.
Other Issues
The original IRS auditor also denied Cathy many other deductions. He wouldn't accept her utility expenses, and a significant amount of her office supplies, field trip expenses, arts and crafts, swimming pool membership, storage unit, gifts, toys, books, cleaning supplies and more.
Unfortunately, Cathy could not find all of her receipts for 2009 and 2010. Despite a thorough search, she concluded that they had been inadvertently destroyed. I had her dig out as many records and receipts as she could, but in the end, she could only produce receipts for about $34,000 of her $65,000 expenses.
Her tax preparer also made a mistake by claiming all of her property tax and mortgage interest as an itemized deduction, rather than claiming the business portion of these expenses on her IRS Form 8829 Expenses for Business Use of Your Home. We got the IRS to correct this by moving 98% of these expenses to Form 8829 where she got bigger tax benefit. (Business expenses reduce Social Security taxes.)
After we won, Cathy was generous enough to write me a thank you letter: "You are an excellent tax attorney and representative for family child care. Thank you for all you have done and continue to do for family child care."
Tom's Comments on the Case
This case is another example of how some IRS auditors don't understand the unique tax rules affecting family child care providers. This case should have been resolved by the original auditor. I don't know why they ignored the IRS documents I presented to support our position.
Unfortunately, we were forced to appeal to Tax Court before we found someone who knew the law.
Appealing can take a long time. Over two years passed from the time Cathy was first audited to when we won in Tax Court. An IRS audit can be very stressful and it's to Cathy's credit that she was persistent in fighting this case for so long.
The result in this case can't be used as a precedent in other IRS audits. That is, other IRS auditors don't have to automatically accept a high Time-Space %. But, you can use my letter to help you argue your position if you are audited. This case is also another example of why you should not hesitate to claim a high Time-Space Percentage if you have the records to back it up.
Tom Copeland - www.tomcopelandblog.com
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