A. To determine deductible business expenses, the provider needs to answer the following three questions :
- Is the expense deductible?
- How much of the expense is deductible?
- When is the expense deductible?
B. Determining if an expense is deductible:
- Must be an ordinary (common and accepted) expense of a child care business
- Must be a necessary expense for the business
C. How much of the expense is deductible?
- 100% deductible (expense exclusively for business)
- Shared expenses (used partially for business and partially for personal, e.g. kitchen utensils)
D. When is the expense deductible?
- If the item costs less than $100, or lasts less than one year, deduct in year of purchase
- If the item costs more than $100 and lasts more than one year, generally must be depreciated (See DEPRECIATION later)
E. Expenses allowable for regulated versus unregulated providers:
- To deduct expenses incurred in the ownership and upkeep of their home, providers must have applied for, been granted, or be exempt from having a license, certification, registration or approval as a family or group child-care home under their state laws.
- If a provider does not meet state requirements, he/she may not claim any of the expenses associated with the operation of their house as expenses of the child care business (the following section explains which expenses are classified as house expenses). Providers who are in violation of state requirements may still claim all direct expenses and personal property depreciation as business expenses.
F. There are three major categories of business expenses:
- Direct expenses are:
- Incurred for use by the business.
- Usually fully “used up” in one year.
- Often both business and personal expenses (i.e. light bulbs, paper towels, and toilet paper). Providers may determine the business deduction by applying their Time-Space percentage or an actual business-use percent.
- Note: Do not use the Time-Space percentage for food costs.
- Claimed on Schedule C of your individual income tax return.
- Appendix 3 contains a worksheet, which can be used to summarize direct expenses.
- Examples of direct expenses:
- Car expenses
- Employee wages & taxes
- Liability insurance
- Business interest
- Legal and professional
- Office expenses
- Bank charges
- Dues & publications
- Education & training
- Rent of equipment
- Laundry and cleaning
- Gifts to children or parents (limited to $25 per year per family)
- Licensing fees (e.g. City business license)
- Household tools
- Business meals & entertainment
- Extra phone services (call holding etc.)
- Toys and games
- Yard tools
- Household items
- House expenses are:
- Associated with the ownership and maintenance of your home.
- Usually claimed all in one year.
- Allocated between business and personal use by applying the Time-Space percentage in most situations.
- Claimed on Form 8829, “Business Use of the Home.” House-related expenses will be deductible in the current year only to the extent that they do not exceed gross receipts from the child care business reduced by certain deductions. Any amounts not currently deductible may be carried forward and deducted in a future year.
- Appendix 4 contains a worksheet, which can be used to summarize house expenses.
- Examples of house expenses include:
- Casualty losses
- Mortgage loan interest
- Real estate taxes
- House insurance
- House repairs and maintenance (furnace repair, fix broken window, etc.)
- Utilities (gas, electric, water, sewer, garbage)
- House rent
- Capital expenses are:
- Purchases made to purchase, improve or increase the value of property, usually with a cost of at least $100.
- Usually spread over a number of years by using depreciation.
- Allocated between business and personal use by applying the Time-Space percentage or an actual business use percent.
- Capital expenses are reported on either Form 4562 (Depreciation expense) or Form 8829 (Business Use of Home).
- Examples of capital expenses include:
- Personal property (computer, TV, VCR, appliances, lawn mower, etc.)
- Major home improvements (remodeling, new roof)
- Land improvements (fence, landscaping, new driveway)
D. Start-up expenses are costs incurred before the date the child-care business is actually open and ready to accept children for care. These expenses could include the costs of advertising, licensing, supplies, etc. If the total start-up costs are less than $5,000 they can be deducted in full in the year the business begins. If start-up costs exceed $5,000 they must be deducted over a period of 15 years.
One type of direct expense requiring further explanation is car expenses:
- There are two methods that can be used to record the expenses of operating your car. For either method you are required to maintain records of the business use of your car. The best method of documenting business use is to maintain a log of all miles driven with indication of those miles that were primarily for business purposes.
- Business use occurs anytime you use the vehicle on a trip that is primarily for business purposes (e.g. a trip to the grocery store when the majority of the grocery purchases are for child care).
- In order to claim any deduction for business use of your vehicle, you will need:
Following is information regarding the two methods of claiming car expenses:
- Total miles driven for year
- Business miles driven for year
- Date placed in service (business use)
- Original cost of vehicle
- The standard mileage rate can be claimed. Under this method, total business miles driven for the year are added together, and multiplied by the standard mileage rate. For the year 2015 the standard mileage rate is $.575 per mile ($.54 in 2016). The resulting amount is claimed as auto expense on Schedule C. If the provider has incurred interest on a loan for the car, a portion of that interest may also be claimed as an expense on Schedule C (the portion of the interest that may be claimed is equal to the total interest times the percentage of the miles driven for the year that were business miles). Additional information regarding the vehicle is required to be provided on Section B of Form 4562.
- The actual car expenses method is the second alternative method that can be used to claim car expenses. In order to use this method of deducting expenses, it is imperative that you keep all receipts for costs of operating the car for the year, including the cost of gas, oil, repairs, tires, insurance, etc. Following are steps to be followed in calculating car expenses under this method
- Add up your total business miles driven for the year.
- Divide the number of business miles by total miles resulting in a percentage of business use for the year.
- Add up all vehicle expenses for the year, and multiply by the business use percentage.
- Calculate the depreciation deduction of your vehicle. The depreciation on the vehicle is claimed on part V of Form 4562; other auto expenses are claimed on Schedule C.