What's a "Red Flag" and Should I Worry About it?
“Will it create a ‘red flag’ with the IRS?” is a common question Iget asked at my family child care record keeping and tax workshops.
Many child care providers worry about putting something on their tax returns that will create a “red flag” and attract the attention of the IRS.
“Will I get audited if I claim a Time-Space % above 40%?”
“Should I claim that I use all the rooms in my home on a regular basis?”
“Is hiring your own child a ‘red flag’?”
It’s human nature for family child care providers to worry about being audited by the IRS. We will do almost anything to avoid it.
The Short Answer
My general answer to these questions is, “If I knew what was a ‘red flag’, I wouldn’t tell you because then you wouldn’t claim what you are entitled to on your tax return.”
The Longer Answer
The IRS computers use complicated mathematical formulas to identify family child care tax returns for audits. What exactly will cause your tax return to be audited is a closely guarded IRS secret. In general, the more out-of-the-norm your tax return is from other child care providers, the more likely you are to be audited.
Here are two situations where you are more likely to be audited:
* You show large losses on your Schedule C for several years in a row.
* Your expenses for a particular line on Schedule C are way out of whack when compared with other child care providers. Let’s say you made $50,000 in income and claimed $25,000 in Supplies on line 22. This will probably attract the attention of the IRS because the supply expense is much higher than what most child care providers spend who make $50,000. No one knows what “average” child care providers spend on supplies by income, so it’s hard to know exactly what will trigger an audit.
The best thing you can do to reduce the chances of an audit is to not lump a lot of your business expenses onto one line on Schedule C. Many providers are tempted to put a lot of their expenses under Supplies because it’s often not clear what other lines to put their expenses on. If your largest expense on any one line on Schedule C is more than twice as much as the next largest expense, then you might want to spread out your some of your expenses over more lines.
On the back of Schedule C are several blank lines that you can use to list your Other Expenses (line 27a). Although there is no rule that requires you to put expenses on any particular line, I encourage providers to use the following expense categories for line 27a: Food, Toys, Cleaning Supplies, Activity Supplies, and Household Items. These general categories can be used to cover many of your business expenses.
I list over 1,000 allowable business deductions in my book Family Child Care Record Keeping Guide and identify which line you can put them on your Schedule C. The Redleaf Press Calendar-Keeper lists business expenses according to the order they appear on Schedule C and uses my Other Expenses suggested categories.
The KidKare online software program also uses my categories of business expenses.
The Best Answer
Don’t worry about being audited. Your chances of being audited are less than 2%.
Make sure that you have the records to back up the numbers you put on your tax return. Then, don’t worry if your numbers might attract the attention of the IRS. No one knows if they will. But, if your records are complete, you will be able to successfully defend yourself if necessary.
Claim the business deductions you are entitled to claim! The worst thing that can happen is that you get audited and might not be able to claim some of them because they weren’t “ordinary and necessary” business expenses. But, by not claiming some expenses to begin with, you are probably paying more taxes that you should!
Tom Copeland – www.tomcopelandblog.com
Image credit: https://pixabay.com/vectors/red-flag-capture-signal-sport-308663/
For more information about audits and how to claim you business expenses, see my Family Child Care Tax Workbook and Organizer.
