Children are the most amazing individuals on the planet… In my opinion. I have 3 of them myself.
As a matter of fact, I love children so much so, that there was a point in my life that I wanted to be able to fill a choir stand with all my children, but after the 3rd one was born – I changed my mind.
However, after having children myself, I saw the importance of having child care.
Child care is essential for those of us who have children who are too young for school, but still need to be looked after while we, as the adults, make a living.
Now… don’t get me wrong and please don’t misunderstand what it is am saying…
I am not saying that school is a daycare.
I am saying that Child Care is an extremely important service to have. And those who provide it are extremely important individuals.
Therefore, as my way of giving back to the child care community, I wanted to make sure that anyone who is in the childcare/daycare industry is fully aware of everything that they are entitled to deduct.
Including the one formula that they need to be aware of.
Please Note: This post also is for those who provide care for those who are 65 and older or persons who are physically or mentally unable to care for themselves.
Because 90% of the time, child care providers offer their services in their homes, it can become confusing sometimes to know what is business and what is personal.
But, as a general rule of thumb, anything someone uses or consumes while in the care of a daycare provider, is deductible.
Therefore, here is a short list of some more common items that may be overlooked:
Can you see where I’m going with this list? I didn’t want to list every single item I could think of, but I did want to kick-start your brain.
Ok, so now that your brain is in gear… let’s have some fun!
Let’s go on a treasure hunt.
Explore your home and look at every single item in your home and ask yourself… Does this have a business purpose? If so, how?
And then write the item down and its business purposes.
Fun right? 😄
During this treasure hunt you may have discovered more items in your home that are used by the individuals that you serve.
And by listing its business purpose, you have made that item deductible.
However, there is something that you need to keep in mind and something that MUST be done in order to deduct these expenses.
Because you use your home for both personal and business, not all of the expenses are going to be 100% deductible.
Therefore, there is one more little exercise that I want you to do.
While making you list of deductible items, create two columns. Label column 1 as “direct” expenses and label column 2 as “indirect” expenses.
Direct expenses are those expenses that are 100% business use. There is not a hint of personal use for those items.
Examples of direct expenses are:
Hopefully you get the idea.
Indirect expenses are those expenses that are used by the whole house… so it’s a mix of business use and personal use.
Examples of indirect expenses are:
Again, hopefully you get the idea.
The “Direct” expenses are fully deductible regardless of anything else.
The “Indirect” expenses are only deductible up to their business use percent (BU%).
What is “Business Use Percent” you ask?
I’m glad you did!
And as the name implies… it’s based on the business use portion of that item.
How is it calculated you ask?
Another great question. One I will answer in just a minute.
But since you asked, it’s a great segway into our next discussion.
Which is main purpose of this post:
The formula that every Daycare provider needs to know.
Did you notice that, in my listing of possible deductions and write-offs, I didn’t mention the biggest one of all…
That’s because to figure how much of your home can be deducted, there a specific formula that must be used.
That formula will give us the BU% of the home. And once we have the BU% we can then use that % and apply it towards the “indirect” expenses to get a deductible amount.
So before we get to the formula… there are a few things and amounts you are going to need to know.
And those are:
Ok so now that we have that information… let’s begin to organize it all.
The theory behind all of those things that you needed to gather is: under normal conditions, in order to deduct the cost of the business use of home, a person would need to pass the “Exclusive Use Test”.
And that test simply states that if the area of home that is used for business, is not exclusively used for business, then it is disqualified and therefore, no deduction can be taken.
However, as a daycare, that test has been excused. And because it has been excused, the way we determine the BU% is slightly different. We need to determine the BU% based on all the things I just asked you to gather.
First let me give you some examples of how those items come into play.
Here is why the square footage is needed:
(This was taken right out of IRS Publication 587)
So, from the example above, we can see that Mary has a BU% of 50%. (I was so tempted to say Mary had a little lamb). Therefore she will get to deduct 50% of all indirect expenses.
Now here’s the kicker…
If the area used for child care has no personal use, then the 50% Business use is all we need to know.
We can deduct 50% of all indirect expenses and 100% of all direct expenses (up to the limit).
But if there is some personal use involved… we have to factor in the element of time.
Here is another example taken straight from IRS Publication 587:
(She – Being Mary from the previous example)
So, using the examples from above, because Mary used her area for both personal and business, her deductions are limited to the following:
Now we finally get to the point of it all…
And here it is:
Sq Ft of area used for business x Sq Ft of entire home = BU%.
Time used as daycare (hours per day x days in week x weeks in a year) x total time in a year (24 x 365 = 8,760 or 24 x 366 = 8,784 for leap years) = Time Use % (TU%)
And when we put it all together, it will look like this:
TU% = % of deductible Direct expenses.
TU% x BU% = % of deductible Indirect expenses.
In order to actually use the business use of home deduction, you must make a profit. Kinda.
The form used to calculate the deduction is the IRS Form 8829.
And on this form, there is line 8. Line 8 is the starting point of the calculation. It is the gross income from your business minus the expenses that has nothing to do with your home, like advertising, mileage, supplies etc.
However, if there is nothing on line 8, then your expenses, both direct and indirect, will be limited.
To be more accurate, if you have nothing on line 8, then you cannot deduct anything below line 15.
On the other hand, if you are a homeowner, you would still be able to deduct the (TU% x BU%) of the mortgage interest and real estate taxes.
Alternatively, there is another way to figure the deduction…
And as the name implies… it’s a simplified way to figure the deduction.
All you must do is determine the square footage of the area used and multiply that amount by $5.
Of course there is a catch.
This only works if the area used for the daycare passes the exclusive use test.
If there is personal use in the mix, then there is a formula involved.
In this instance, we will use the TU% formula and multiply the result by $5. The remaining amount of $ is what we will use to multiply the square footage by to get our deductible amount.
Also note that the sq ft has a max of 300. So the max credit allowed under the simplified method is $1500 ($5 x 300 sq ft)
So there you have it.
I know that this was a lot of information to consume. But, I’m glad you made it to this point, because now you have a good understanding of what you need to be prepared for come tax time.
Just make sure to keep detailed records and you will be good to go.
And to help with all these formulas and calculations, I have developed a tool to help you figure out your possible deduction.
Just enter your information below and it will be delivered to you immediately!
Take care and if you have any questions please let me know.