29 E. Madison, Suite 910, Chicago, Illinois v: f:

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1 Welcome to the Family Child Care Tax Project, a program of the Center for Economic Progress. Since 1997, we have provided thousands of home-based child care providers with information on business practices, income taxes and recordkeeping. Our goal is to help providers sustain and grow their businesses, so they can continue to perform the valuable service of child care for Illinois working families. 29 E. Madison, Suite 910, Chicago, Illinois v: f: Over the past six years, we have conducted 120 tax and recordkeeping classes and have trained over 2300 providers, some of whom are licensed and subsidized, while others are either license-exempt or are just starting out. The classes listed below are designed to educate and support all levels of home-based child care providers who seek to build and improve their businesses. Basics of Taxes & Recordkeeping: This class introduces the fundamentals of taxes and recordkeeping, with practical information and advice that is useful to any child care provider. Business Issues: Insurance, Policies & Agreements: The intermediate level class provides information and generates discussion around issues involving insurance and the importance of establishing policies and agreements. Advanced Tax Issues: The final class supplies an overview of more complex tax issues, including depreciation and employer issues, and the related recordkeeping requirements. We hope that you will be able to attend all three classes. Our experience indicates that providers who gain business knowledge and use good recordkeeping techniques experience increased efficiency and less anxiety, while gaining the respect of their customers and colleagues. If you have questions concerning your taxes or recordkeeping after today s class, or if you are interested in scheduling a class for another group, call Sara Reschly at (312) ext. 268 or send an to taxtraining@economicprogress.org. Sincerely, Sara Reschly Special Projects Manager Barbara DelBene Senior Training Specialist info@economicprogress.org

2 Table of Contents INTRODUCTION BASIC Center for Economic Progress... 4 Class Materials Meet Your Instructors I. What It Means to Be Self-Employed The Good, the Bad, and the Ugly... 8 Lillian s Tax Return Providing Information to Parents Federal Employer Identification Number II. Income Issues Income Sources Methods of Tracking III. Time-space Percentage Determining the Time Percentage Determining the Space Percentage Computing the Time-Space Percentage IV. Expenses...30 Regular Business Expenses Saving Receipts Business Expense for Food Telephone Expenses Transportation Expenses Medical Expenses Nondeductible Expenses Startup Costs Business Use of the Home V. Recordkeeping Introduction The Eight Rules of Good Recordkeeping Recordkeeping Software INTERMEDIATE VI. Insurance Issues...46 Why get Insurance? What Insurance Does a Child Care Provider Need? Steps to Secure Insurance Avoiding Risks Childcare Training Center for Economic Progress

3 Table of Contents VII. Policies and Agreements Why Develop Policies and Agreements Issues to be Addressed in Policies Getting Started Sample Agreement ADVANCED VIII. Depreciation Basis Computation Special Rules Records Disposition of Business Assets Catching up on Unclaimed Depreciation IX. Employer Issues Background Responsibilities Step by Step Explanation of Basics Annual Employment Tax Payroll Example Summary of What You File and Why X. Estimated Taxes Who Pays Estimated Taxes? How Do You Estimate Your Taxes? When are Estimated Payments Due? Penalties XI. Other Issues...81 Business Entities Planning for Retirement Dependent Care Plans Professional Development Appendix Tax Forms & Publications Forms for Employers Glossary of Acronyms Tools and Resources Tax Preparers Childcare Training Center for Economic Progress

4 Introduction A. CENTER FOR ECONOMIC PROGRESS Overview of the Center If you re reading this, you probably know that the Center for Economic Progress provides free training to child care providers. What you may not know, however, is that we do so much more. From innovative programs to bold advocacy initiatives, we offer a comprehensive array of programs and services to serve and empower low-wage residents of Illinois and beyond. We believe that by providing options and opportunities, while raising awareness about ways they can keep more of what they work so hard to earn, the families and individuals we serve can and will make economic progress. How We Make a Difference Teach The Center holds many specialized trainings, such as this one for child care providers, as well as others for foster and adoptive parents and community organizations to help them learn how to navigate the tax code. We also provide financial education to working families, giving them the knowledge they need to move from poverty to prosperity. Solve The Center helps working families solve their tax issues with the IRS. Through our tax clinic, we provide professional legal services to families facing difficult financial circumstances. Serve Through our free tax preparation program, we provide access to financial products and services as well as critical tax benefits such as the EITC the nation s strongest anti-poverty tool. Lead Through our National Community Tax Coalition, the Center leads a 600-member strong team of like-minded community organizations in national advocacy efforts to ensure that working families keep more of what they earn and have a chance to make a living not just survive. Take Action The Center advocates throughout Illinois on behalf of working families, working to encourage fair and responsible practices by the private sector. We make a difference in the lives of thousands of working families and individuals. Join us! If you d like to take advantage of another service the Center offers, just give us a call. Whether you want to learn to make a budget (and stick to it!), get your taxes done for free or solve a tax problem, we re here to help. Directors David Marzahl, Executive Director Greg Fields, Senior Director of Administrative Operations Mary Ruth Herbers, Senior Director of Programs Raissa Allaire, Senior Director of Marketing and Development Rolando Palacios, Tax Services Jackie Lynn Coleman, Capacity Building and Training Erika Schafer, Financial Services Jonathan Njus, Advocacy Michael Green, Information Technology Childcare Training Center for Economic Progress

5 Family Child Care Tax Project Sara Reschly, Special Projects Manager Larry Garner, Assistant Director, Tax Services Barbara DelBene, Senior Training Specialist O. S. Owen, Senior Training Specialist Alejandro Costilla, Consultant Joanne Capparelli, Program Assistant, Tax Services Chicago Office 29 East Madison Street, Suite 900 Chicago, IL Tel: (312) Fax: (312) Springfield Office 516 E. Monroe, Suite 501 Springfield, IL Tel: (217) Fax: (217) Website: B. CLASS MATERIALS (1) Training Manual The staff of the Center for Economic Progress has developed this training manual based on our assessment of the needs of family child care providers. The information comes from our experiences preparing tax returns for child care providers at our free tax sites, as well as conducting seminars for child care providers. Except for a few identified exceptions, the tax information in this manual refers to federal income tax. (2) IRS Forms and Publications The Internal Revenue Service provides a wealth of free information for small business owners. The basic class provides Publication 587, Business Use of Your Home, which has a separate section for home-based child care providers. The advanced class provides Publication 15, Circular E, Employer s Tax Guide. Sample IRS forms and instructions are also included in this manual. (3) Calendar-Keeper The Calendar-Keepers were purchased from Redleaf Press, the publishing division of Resources for Child Caring (RCC). Several sample forms in this manual are extracted from Redleaf publications. RCC is a nonprofit agency in St. Paul, Minnesota that specializes in resources related to child care and is dedicated to raising the standard of care for children by supporting care givers. Childcare Training Center for Economic Progress

6 C. MEET YOUR INSTRUCTOR Alex Costilla has worked as a financial accountant for the McDonald s Corporation for the past 6 years. He has been a tax site manager for the Center for Economic Progress and has been providing training to home-based child care providers on recordkeeping for four years. Alex has a degree in accounting from the University of Illinois at Chicago. He is also currently serving as Treasurer for Proveedores en Accion para Nuestros Ninos-- PAAN (Association for Child Care Providers). Barbara DelBene is an Enrolled Agent with over 25 years of tax experience, and a senior training specialist for the Center for Economic Progress. She develops curriculum, writes the training manual, and trains instructors for the Center s volunteer tax preparer training program. Barbara writes tax training materials for home-based child care providers and foster parents, as well as providing technical assistance on quality and training issues to the National Community Tax Coalition (NCTC). Barbara is a technical adviser to the Center s advocacy department and is a member of the NCTC Quality Working Group. Larry Garner is currently the Assistant Director of Tax Services for the Center for Economic Progress. Larry is involved with the Family Child Care Tax Project by providing basic income tax information and tax planning classes for home-based child care providers. He also has taught classes about tax benefits available to foster and adoptive parents. Larry graduated from Kansas State University in 1977 and has worked in various states in the accounting and tax field for over 20 years. In 1980 Larry became a licensed CPA and has extensive experience working with low income taxpayers. O.S. Owen, Senior Training Specialist, has been with the Center since March He instructs classes for volunteer income tax preparers and teaches child care providers about recordkeeping and taxes. O. S. provides financial coaching and counseling to a network of 12 organizations, the Centers for Working Families. He has over 12 years of experience in dealing with intergovernmental affairs with FDIC and the Department of Labor, credit rehabilitation, debt management, tax related counseling and tax preparation. He holds a Bachelor s Degree from Morehouse College and lectures at Harold Washington College, one of the City Colleges of Chicago. Sara Reschly is the Special Projects manager at the Center for Economic Progress. She coordinates and recruits new community partners to host the tax and recordkeeping trainings for home-based child care providers. She promotes the delivery of high quality training by assisting with the development of the curriculum and training of instructors for the agency s tax training programs. Sara also coordinates the training of 1000 volunteers who help the Center provide free tax preparation and financial services to low-income workers. Childcare Training Center for Economic Progress

7 Basic Learning Objectives 1. Gain awareness of the important tax benefits and responsibilities of being self-employed. 2. Understand advantages of obtaining a federal employer identification number. 3. Learn how to track hours and understand the benefits of using the time-space percentage. 4. Understand basic income reporting and recordkeeping requirements. 5. Understand the standard meal allowance advantages and recordkeeping requirements. Childcare Training Center for Economic Progress

8 II. What It Means to Be Self-employed When a taxpayer earns income that is not wages, that taxpayer is considered to be self-employed. Home-based child care providers are self-employed. There are advantages and disadvantages to being a self-employed child care provider. A. THE GOOD NEWS You can deduct a wide variety of expenses. You do not need to itemize deductions to claim expenses. There is no standard income percentage limit to your deductions. The cost of using your home for business is deductible. You can consider the time, as well as the space used in the home, when computing business deductions (time-space percentage). No taxes are withheld from your income. B. THE BAD NEWS No one keeps track of your income or expenses for you. In addition to income tax, you must pay your own social security and Medicare taxes. This is called self-employment tax and it is about 15% of your net business income. No taxes are withheld from your income. If your tax liability is not covered by tax credits, you may be responsible for making quarterly estimated tax payments. You must keep good records of both income and expenses. C. THE UGLY NEWS If you pay someone to prepare your tax return, it will probably cost you more than the average taxpayer. Tax return preparation is significantly more complicated when you are self-employed. See the following pages for a sample of a basic tax return for our prototype family child care provider, Lillian Dove. Reprinted from United Feature Syndicate Childcare Training Center for Economic Progress

9 Childcare Training Center for Economic Progress

16 D. PROVIDING INFORMATION TO PARENTS Child care providers are required to give identification information to parents. Most parents need this information so they can receive a tax credit based on child care expenses that they paid. The tax return schedule that parents file with their federal income tax return is Form 2441, Child and Dependent Care Expenses. This form requires the parents to provide the name, address and taxpayer identification number of the child care provider. This credit is available to parents who pay the entire cost of child care, as well as families who receive Child Care Assistance Program (CCAP) assistance. Families who receive CCAP assistance use the amount of co-payments to compute the credit. When parents file their income tax returns, they need the following information. Your name Your address Your federal employer identification number or social security number Total amount paid for child care for each child during the year Providers are required to give parents the first three items; the fourth item is optional. The identification number given to parents can be either the provider s federal employer identification number (FEIN) or social security number (SSN). For privacy reasons, most providers use a FEIN. See the next section for information on how to obtain a FEIN. SPECIAL NOTE: If a parent makes a request, you are required by law to provide your name, address, and identification number. The IRS can assess a $50 penalty against a child care provider for each instance of failure to provide this information to parents. Although child care providers are not required to give parents a total amount paid for the year, it makes good business sense to do so. First, parents need that amount in order to claim a tax credit on their tax return. Second, giving the parents the amount paid is a wise, professional service that will help to avoid future disagreements over amounts paid. We have provided two examples of how a provider could provide this information to parents: a letter and IRS Form W-10, Dependent Care Provider s Identification and Certification. Do you want a disagreement between you, your customer, and the IRS about how much you were paid for child care services? Childcare Training Center for Economic Progress

18 E. FEDERAL EMPLOYER IDENTIFICATION NUMBER Because of privacy and identity theft issues, it is better to give out a FEIN number than your SSN number to parents at the end of the year. The federal employer identification number (FEIN) is an identification number, issued by the IRS to businesses and other tax entities, that is used for a variety of purposes. Originally, it was developed to file federal employment tax returns, thus the name. Form SS-4, Application for Employer Identification Number, is used to apply to the IRS for the FEIN. You can download the Form SS-4 on or call IRS at (800) to have it mailed to you. There are four ways to get a FEIN from the IRS. 1. Online Application Go to Enter IRS keyword: online EIN Select: Apply for an EIN Online Select: Apply Online Now Select: Begin Application Select: Sole Proprietor Select Started a new business (Even if you have been in business for a long time, you should still answer started a new business because the online form does not have other as an option. The instructions say choose an answer that is closest to your situation and, in most cases, started a new business will be the closest.) You will be directed to enter your information. 2. Mail Form SS-4 Internal Revenue Service Attn: EIN Operation Cincinnati, Ohio Fax the Form SS-4 to IRS at (859) Telephone IRS Call (800) Hours: 7:00am - 10:00pm (CST) There are several advantages to having a FEIN: You don t have to give out your social security number. The FEIN can be used to open a business bank account. You use the same FEIN to file employment tax returns. NOTE: In the past, the IRS was reluctant to issue a FEIN to a business without employees. In recent years, however, the IRS will process a FEIN application for child care providers who need the number only for privacy reasons. Childcare Training Center for Economic Progress

20 II. Income Issues A family child care provider must keep track of her own income. There will be no W-2 mailed at the end of the year showing the amount earned. Although many providers receive a Form 1099-MISC from the state, it is just part of the total income. Good records will ensure that all of the proper income is reported and that no duplications occur. NOTE: Net income from self-employment (gross income from your business, less business expenses) is considered earned income for purposes of computing the Earned Income Tax Credit, the refundable Additional Child Tax Credit, and the new Making Work Pay Credit that is effective for tax year A. INCOME SOURCES (1) State Payments Many Illinois providers have customers who receive assistance from the state Child Care Assistance Program (CCAP). The amounts paid to you through CCAP are recorded by the state and the total amount for the year is reported to you, and to the IRS, on Form 1099-MISC. Childcare Training Center for Economic Progress

21 (2) Co-Payments Your customers that are using the CCAP assistance make co-payments directly to you. It is your responsibility to document the amount received in co-payments and add them to the total income for your business. (3) Other Customers Some parents pay the entire cost of child care. Many providers refer to these customers as private customers. Although this income is not recorded or tracked by the state or other agencies, it must be reported on a provider s tax return. It is your job to keep track of how much you are paid each year. (4) Food Program Many providers participate in the USDA s Child and Adult Care Food Program (CACFP). Payments from this program should also be reported as part of the income for the child care business. The monthly claims submitted for reimbursement serve as a record of this income. (5) Bartering The amount spent on food for the children under your care is a deductible business expense. It is OK if the amount spent is more than the payments received from the CACFP. The extra amount that you spend results in a reduction to the taxable income on your return. IRS Publication 587, Business Use of Your Home, suggests that the provider just take a deduction for food expense, less USDA reimbursement, instead of reporting all of the food program payments in income. However, this method does not provide important information that is relevant to the business income. Many tax experts who specialize in child care provider returns recommend reporting all food payments as income and deducting all food expenses. If you are receiving CACFP reimbursement for food for your own children, that amount is not included in the amount you report as income. Also, the amount spent on your own child s food is not deductible. Example Sheila takes care of four toddlers. Three children are child care customers and one is her daughter. Sheila is paid $1,000 by the food program. She will include $750 as business income and she will not report the $250 that was paid for her daughter. She will take a deduction for the cost of meals served to the three children that she feeds as part of her child care business. If a provider takes care of someone s child in exchange for non-cash reimbursement or services, the value of that reimbursement must be reported as income to the child care business. Sometimes a provider exchanges child care services for child care services. The amount of income reported is the value of the child care service that was received. Example 1 You take care of your neighbor s three children for one day in exchange for her taking care of your own three children for another day. If the normal charge for three children for one day is $50, you include $50 in your business income. Since the children the neighbor took care of were your own children, you do not take a business deduction; however, you have a $50 personal child care expense that you may be able to use to compute a child and dependent care tax credit, Form Example 2 You take care of your husband s coworker s baby for one day in exchange for the co-worker installing a swing set for your business. If the normal charge for swing set installation is $30, you include $30 as business income and add $30 as an installation charge to the cost of the swing set. Childcare Training Center for Economic Progress

22 (6) Lillian s Income Lillian has the following sources of income for her business. State of Illinois (reported to her on Form 1099-MISC) $11,500 Co-payments (cash from customers using state CCAP) $839 Private clients $5,983 USDA s Child and Adult Care Food Program $3,256 Total Gross Child Care Income $21,578 B. METHODS OF TRACKING The following examples describe methods that may be used to keep track of income. (1) Some kind of CALENDAR is generally used to track income. The Calendar-Keeper monthly attendance and payment logs are specially designed for tracking the amounts due and collected from parents each month. NOTE: Income can be recorded on a hard copy calendar, or using calendar or recordkeeping software. Either way, it is important to track days and hours of attendance, amount charged for the child care services, and amounts that are paid to the child care provider. Exercise: Imagine that you charge $1.00 per hour for each child in your care. You care for a child named Julian who stays with you for 5 hours each day, Monday through Friday. Julian s mother paid you $50 on March 13 and $20 on March 20, for the first three weeks of the month. Julian s family went on vacation the last week of the month, from March 23 through March 27. On the blank line, enter the attendance and payment information for Julian. How much does Julian s mother owe you on April 3? Reprinted from Redleaf Press Childcare Training Center for Economic Progress

23 (2) A RECEIPT BOOK may be used in addition to the Calendar-Keeper. Parents like receiving a receipt for amounts paid, particularly when they have paid in cash. Receipts also help parents at tax time, when their child care payments may result in a tax credit. Receipts can also resolve disputes over amounts paid and owed. NOTE: Some providers find it useful to keep a separate receipt book for each family. Do I know how much money has come into my business so far this year? Do I know which families owe me and how much they owe? If the answer to either question is no, you need better income records. Childcare Training Center for Economic Progress

24 III. Time-Space Percentage One of the big challenges for child care providers is identifying and separating business expenses and personal expenses. For most providers running a home-based business, the business expenses and personal expenses are comingled. The time-space percentage is a great tool that can be used to determine the deductible business portion of expenses. The timespace percentage was designed to address the problem of separating business and personal expenses and serves to simplify recordkeeping for home-based child care providers. Tracking the necessary information and computing the time-space percentage may seem daunting at first. However, once the time-space percentage is determined, it can be applied to almost any item that is used in your home for business. Once you have determined your time-space percentage for each year, you can use it to figure your tax deduction on a wide variety of expenses, including the following. rent utilities home repairs home insurance home improvements furniture and appliances small household equipment, such as towels, curtains and rugs depreciation household items, such as cleaning and cooking supplies house depreciation mortgage interest real estate taxes Example: You bought a throw rug for $20 to put inside the front door so people coming in can wipe their feet before entering the living room. You, your family, the day care kids, and day care parents will all wipe their feet on this rug. Do you want to somehow keep track of how many business-related feet and how many family-related feet use the rug? Keep a journal? No! If you know that your time-space percentage, is, say, 25%, you can deduct $5 as a business expense without any additional recordkeeping. A. DETERMINING THE TIME PERCENTAGE You need to know the number of hours that your home was used for your business. The time percentage is the total business hours for the year divided by total hours in the year (24 hours in a day times 365 = 8,760 hours for most years). Time Percentage = business time total time The business hours for your home have two components. The sum of the two is used to compute total business hours spent in the home. (1) Time spent caring for the children Count the hours from the time the first child arrives in the morning until the last child leaves at night. If you keep a regular schedule, your records can just reflect the normal schedule. For example, if you are always caring for children from 7:00 am to 5:00 pm, Monday through Friday, you count 10 hours a day for five days, or 50 hours per week. If you have mostly part-time children or other irregular hours, keep track of actual hours on a calendar or attendance log. Childcare Training Center for Economic Progress

25 (2) Hours working in your home when the children aren t there You can also count the time that you do work related to the child care business when the children are not there. Here are some examples of time that you could count. cleaning cooking making repairs decorating for a birthday party meal planning filling out forms for food program preparing craft projects researching child care issues talking to parents or prospective customers on the phone making fliers for advertising filling out your Calendar-Keeper and other recordkeeping activities Am I doing this for myself, my family or because I have this child care business? If you are in your home and doing it because you run a child care business, count the time. You will need to keep track of how many hours you spent working on your business in your home when the children are not there. Even if you keep a regular schedule for the children, your hours when they are not there will vary. At the end of every day or week, write on a calendar the time spent working when the children are not there. As an alternative, you could periodically keep detailed records of exact time spent for a typical week and compute an average. CAUTION! Unless your recordkeeping software is designed specifically for home-based child care providers, it will probably not provide a method for tracking business hours. However, any component provided for tracking daily items could probably be adapted to record business hours. Example Here is how Lillian figured her time percentage. She kept detailed records of her time for two months: March and September. This method works because she was in business all year without variation in schedule. She took a two-week vacation. Children are present Cleaning, cooking etc. Total business hours 45 hours per week 10 hours per week 55 hours per week Lillian s Time Percentage for hours x 50 weeks = 2,750 business hours 2,750 8,784* (total hrs. in the year 2008) = 31.31% time percentage. * 2008 was a leap year. Exercise: In your Calendar-Keeper, fill out the hours that you spent on your business during the past week when the children were not there. See the next page for an example of one way to track these hours. Childcare Training Center for Economic Progress

26 Childcare Training Center for Economic Progress Reprinted from Redleaf Press

27 B. DETERMINING THE SPACE PERCENTAGE Business space is space that is always available for child care use and is regularly used for business. This would generally include the main living areas, such as the kitchen, playroom, laundry room, office, bathroom, living room, and entry area. NOTE: A certain part of your home will be licensed for child care. Your business space for tax purposes is not limited to the licensed space. Business space for tax purposes includes all business space, not just the area used by the children. For example, the children may never go into your office, but it is business space because you use it for your recordkeeping. ALSO NOTE: Storage can also count as business use. For example, you store your car that you drive for business in your garage, so the garage is business space. The idea is to figure out what portion of your home is used for the child care business. You do this by finding out how much space is used for child care and dividing that by the total amount of space in your home. Space Percentage = business space total space in home Determining business space is generally pretty straightforward. In many cases, most or all of your home will be considered business space. Here are some examples of situations that might not be so clear cut. Rooms that would be included: The children are not allowed to play in your teenage son s room, but a toddler naps in there every afternoon. The children are never allowed in the laundry room, but you use it to wash bibs, sheets, and other items related to your child care business. Rooms that would not be included: Your four-year-old daughter doesn t let the child care kids in her room. She naps in her room during the afternoon when you are open for business. You do not let the children play or nap in your sewing room. A couple of times during the year, you kept a sick child in the sewing room to avoid infecting the other children. Childcare Training Center for Economic Progress

28 Example Computation of Space Percentage Space used for business: Living room Kitchen Playroom Back room Bathroom Laundry Basement Total 550 sq. ft. 425 sq. ft. 350 sq. ft. 275 sq. ft. 150 sq. ft. 200 sq. ft. 300 sq. ft. 2,250 sq. ft. Space not used for business: Total Home Area: Bedrooms 3 x 200 = 600 sq. ft. Space Used for Business 2,250 sq. ft. Bathrooms 2 x 75 = 150 sq. ft. Space Not Used for Business 750 sq. ft. Total 750 sq. ft. Total 3,000 sq. ft. Space percentage: = 0.75 or 75% (2,250 sq. ft. business divided by 3,000 sq. ft. total home area = 75 % space used for business) Lillian s Space Percentage for 2008 Lillian s apartment has 1250 sq. ft. of space. All of it is used in the child care business, which means that she has 100% space percentage. C. COMPUTING THE TIME-SPACE PERCENTAGE Once the time percentage and the space percentage are determined, they are multiplied to compute the final time-space percentage. time % x space % = time-space % Lillian s Time-Space Percentage for 2008 We previously determined that Lillian has a 31.31% time percentage and 100% space percentage.. Her time-space percentage would be computed as follows % x 100 % = 31.31% time-space percentage Look at Part I of Lillian s Form 8829, Business Use of Home, to see how this is shown on the tax return. Childcare Training Center for Economic Progress

30 IV. Expenses There are two main categories of business expenses: A. Regular Business Expenses B. Business Use of the Home A. REGULAR BUSINESS EXPENSES Regular business expenses are an important and complicated issue for child care providers. This topic is covered in eight sections: 1) Overview 2) Saving Receipts 3) Business Expense for Food 4) Telephone Expenses 5) Transportation Expenses 6) Medical Insurance 7) Nondeductible Expenses 8) Startup Costs 1) Overview Regular business expenses include a wide variety of items used in the child care business that are not part of the cost of running and maintaining your home. For instance, advertising is not considered part of the cost of running the home. Regular business expenses are deducted on Schedule C, Profit or Loss From Business. Expenses for items that are used only for the business are fully deductible. Other expenses are related to items that are also used for personal purposes (for example, washer and dryer). These expenses that are a mixture of business and personal are only partially deductible. Regular business expenses fall into three categories: 1. fully deductible (example: Calendar-Keeper) 2. partially deductible based on time-space % (example: kitchen clock) 3. partially deductible based on actual use (example: computer printer) NOTE: Items purchased for your business that will last longer than one year and that cost more than $100 are called capital expenditures. They cannot be deducted as an expense. Instead, they must be depreciated. See Chapter VIII, Depreciation, for more information. The following is a list of example items that may be regular business expenses: toys, games, videos craft supplies, such as paper, glue, crayons equipment, such as dishes, blankets, baby bottles party decorations gifts to the children and parents (limit $25 per gift recipient per year) advertising, such as flyers promoting your business professional dues and subscriptions office supplies, such as calculator, pens, paper union dues insurance purchased because of the business Childcare Training Center for Economic Progress

31 Some of Lillian s Expenses Lillian had advertising costs in 2008: Copy fees and paper for flyers $37 Custom made sign $20 Total advertising $57 She also had expenses related to her own professional development. For example, she paid dues to join an organization for Illinois child care professionals. Dues $ 75 Child Care Expo fee $ 50 Total professional expenses $125 Do I use this item in my child care business? If the answer is yes, it is probably a deductible business expense. NOTE: If you have small children in your family, things like toys would not be a 100-percent deductible business expense. Example In your day care business you take care of three small children. You also care for your own 3-year-old daughter. You pay $90 for a little play kitchen that all four children use. It would be reasonable to deduct 3/4 ($67.50) as a business expense. Lillian s Toys Lillian spent $578 on toys to be kept in the room where the child care children play. When the business is open, both Lillian s two children, as well as the four children in day care, play with these toys. So four out of the six children represent business use. Therefore, she is deducting 2/3 of the cost as a toy expense. 2/3 of $578 = $385 toy deduction. 2) Saving Receipts Save your receipts. If you don t get one, ask. If a receipt reflects purchases both for business items and personal items, write on the receipt to indicate which things are for business. It is best to purchase business items separately from personal items, as this will improve accuracy and simplify recordkeeping. Items purchased with a debit card can be tracked with bank statements. Saving cancelled checks is OK, but a check does not provide any detailed information about what was purchased. NOTE: You should also keep a log of what is purchased for the business. This can be in a central location, such as the Calendar- Keeper, or written on the outside of the folder or envelope where you keep the receipts. If logging expenses using recordkeeping software, make sure that each record clearly indicates the business purpose of each expense. Childcare Training Center for Economic Progress

32 The sales tax paid on items purchased for your business is part of the deduction. When there are business items and personal items in one purchase, be sure to add the sales tax amount to the cost of the business items. If you are not sure what the sales tax rate is, consult the Illinois Department of Revenue: Follow the link Tax Rate Finder. Reprinted from 3) Business Expense for Food Tracking food costs is an important part of recordkeeping for home-based child care providers. Food is a big expense that is often mixed up with the food costs for the provider s own family. This is further complicated by the fact that food consumed by the provider and her own children is not deductible. In response to these difficulties, the IRS developed Revenue Ruling in February 2003, which provides an easy option a standard meal allowance deduction for home-based child care providers. There are five basic methods from which providers can choose to track and compute food expenses: 1. Standard Meal Allowance 2. Use only Food Program Amounts 3. Record Extra Expenses Only 4. Save All Receipts 5. Develop Average Costs The standard meal allowance is the recommended method. It has the simplest and easiest recordkeeping requirements. Childcare Training Center for Economic Progress

33 Method 1 Standard Meal Allowance It is not necessary to keep receipts for food purchases for this method. Providers must only keep records to reflect the number of meals served. The records must include: name of each child dates and hours of attendance type and quantity of meals and snacks served This means with relatively few records, a provider can choose to automatically deduct standard amounts for meals served to children in their care. The amounts are based on the USDA Tier 1 rates. Providers are allowed to deduct a maximum of three meals and three snacks per child per day. Standard meal allowance amounts are: Breakfast $1.11 $1.17 Snack $0.61 $0.65 Lunch/supper $2.06 $2.18 A blank weekly meal form that can be used to record this information is on page 95 of the 2009 Calendar-Keeper. A year-end meal tally is on page 96. Remember! There is only one blank meal form per Calendar-Keeper. Make 52 copies of the blank form, one for each week of the year, and use the copied forms for your records. Tracking and adding up meal records is a good use of recordkeeping software. If the program is specifically designed for child care providers, there should be a special system in place for tracking meals. If general recordkeeping software is used, a calendar function or basic spreadsheet could be adapted to record and add up the meal information. Exercise On the meal form, enter Jeremy Jones meals for the week of March 16. Jeremy was sick that Friday, so he did not come to daycare. Otherwise, he was there from 8:00 am 1:00 pm. He ate breakfast, one snack, and lunch at day care. Once you have completed Jeremy s meals, total the meals served for the week in the Weekly Totals box. Lillian s Food Expense Lillian used the standard meal allowance. When she totaled up all her spreadsheet records for meals, she was amazed at the amount of food she served in ,123 Breakfasts 1,123 x $1.11 = $1, ,247 Lunches 1,247 x $2.06 = $2, ,716 Snacks 2,716 x $0.61 = $ Suppers 10 x $2.06 = $ Total food deduction $5, NOTE: The standard meal allowance is based on meals and snacks served. Even if the kids don t eat it, if you served it, you get the deduction. Childcare Training Center for Economic Progress

34 Childcare Training Center for Economic Progress Reprinted from Redleaf Press

35 Method 2 Use Only Food Program Amounts Some providers don t want to bother with keeping any records in addition to those required by the food program. This is somewhat risky. Most providers will end up with a smaller deduction and therefore pay more in taxes. Example Income from food program $3,500 Cost of basic meals - $3,500 Total food deduction $3,500 Net effect to business income $ 0 NOTE: Even though this has no net tax effect, both income and expenses should be reported. Method 3 Record Extra Expenses Only In this method you deduct additional food expenses for which the USDA did not reimburse you. Keep tax records only for food that is not covered by the food program, such as birthday cakes and special treats. If you are on the USDA food program, you have the advantage of already keeping records to comply with USDA rules. However, most providers find that they spend more on food for their business than the USDA will reimburse. Example Income from food program $3,500 Expenses: Cost of basic meals $3,500 Special food (parties, extra snacks) $ 400 Total food deduction - $3,900 Net business deduction for food $ 400 Method 4 Save All Receipts This method requires that the provider keep all receipts for all food purchases both business and family - for the year. It also requires specific, separate documentation to identify business and family food. If thoroughly carried out, this method will give the most complete and accurate figures for food cost. This method, however, is cumbersome and time consuming. Method 5 Develop Average Costs The provider keeps detailed records of food cost for representative time periods in order to compute an average cost per meal. For instance, a provider would keep excruciatingly detailed records for two-week periods, four times a year, and use that data to compute an average cost of meals served to the children. Then the provider just needs to know how many meals were served and determines the cost of those meals using the averages. This is similar to the IRS standard meal allowance, except that you are computing and substantiating your own average meal allowance. CAUTION! Now that IRS provides a standard meal allowance, it would seem that a provider that uses a higher cost-permeal needs substantial justification for the larger deduction. 4) Telephone Expenses The basic cost of the first phone service for your home is never a deductible business expense. However, additional telephone costs that are related to your business are deductible, such as: additional phone line for the business Childcare Training Center for Economic Progress

36 long distance business calls cost of a separate business listing in the phone book The cost of buying and using a cell phone for your business is deductible. In most cases, cell phone use will be a combination of business and personal calls. Since you can only claim calls related to business, you would need to have records to show the percentage of business use. You could keep a log of the number of calls made, and mark each business or personal. Many carriers provide very detailed bills that could be helpful in determining business percentage. To avoid keeping records you may use the time-space percentage. How much more am I paying for phone service because of my business? 5) Transportation Expenses Transportation expenses that are related to your business activities are deductible. This section primarily discusses the deduction for using your own vehicle. However, it is also important to note that the cost of public transportation for business trips is fully deductible. Keep a log to record bus and train fare, taxicabs, etc. You can add these expenses to your transportation deduction. If you use your car (van, jeep, etc.) in your business, part of the cost of buying and maintaining that car is deductible. You must keep track of the number of business miles driven and total miles driven for the vehicle. Whenever the primary purpose of a trip is business, the mileage is considered business mileage. There will almost always be some personal miles on the vehicle that must be considered - even if you have painted the name and logo of your child care business on the side of the van. Is my main reason for driving to the grocery store for my family OR to shop for my child care business? If most of the items you purchase are for your business, all of the mileage to and from the grocery store is business mileage. If you buy lots of grocery items for your family and just a couple of things for your business, then none of the miles are business miles. Childcare Training Center for Economic Progress

37 HINT: Write down your business miles right away. Keep a notebook in the car, a note pad in your purse, or write it on a calendar inside your back door. CAUTION! Recordkeeping software that is designed for small businesses may require special entries to track non-deductible commuting miles. As a home-based child care provider, commuting is not an issue because your home and your business are the same location. As soon as you pull out of your driveway on a business trip, you are driving deductible business miles. When you start using a car in business, you can choose between two methods for computing automobile expenses: standard mileage rate; or, actual cost method. NOTE: If you select the actual method, you cannot change to the standard mileage rate in subsequent years for that vehicle. CAUTION! Regardless of which method you choose to use, you must keep track of business miles driven for the year. Standard Mileage Rate Method If you use the standard mileage rate, you deduct an amount for each business mile that you drive during the year. The standard mileage rate is: per mile per mile (January June) 58.5 per mile (July December) per mile The standard mileage rate covers the cost of the vehicle, gas, oil, repairs, regular car insurance, and licenses. The only amounts that you can add to the standard mileage deduction are parking, tolls, interest on your auto loan, and any additional insurance you may purchase to cover the child care children in the car. Actual Cost Method If you use the actual cost method, you must keep receipts for all of the gas, oil, repairs, and any other expense related to the vehicle. In addition, you must also keep records of mileage to determine the number of business miles, as well as total miles for the tax year, to determine the percentage of business use. You also compute depreciation on the cost basis of the vehicle; however, there may be special limitations on depreciation when the business use of the vehicle is less than 50 percent. Do I want to keep all of those little pieces of paper for gas purchases? Will other people in my family who drive this car keep all of those receipts, too? If the answer to either question is no, you probably should choose the standard mileage rate method. Exercise: Practice keeping track of mileage. Make a note of your business trips from the past three days. Be sure to also include your mileage or expenses for getting to today s class. Childcare Training Center for Economic Progress