Depreciation and deduction

The Basics of Depreciation

Depreciation is the most complicated tax issue family child care providers face.

It's complicated because there are so many rules associated with it and they often change from year to year. And there's a lot of math involved! What fun.

What is depreciation?

Depreciation is the process of spreading the deduction of an item over a number of years, rather than deducting it in one year.

You must depreciate any item you purchase costing $500 or more that you use in your business. You are also entitled to depreciate any item you owned before you went into business that you start using for your business.

Here's a basic example of how depreciation works.

Let's say you bought a $1,000 refrigerator.

1) How much of the refrigerator can you depreciate?

Since you are using it in your business, you can deduct it. Since it costs more than $500 you must depreciate it. Since it's used by your family and your business, you can't depreciate the entire cost.

Therefore, you will use your Time-Space Percentage to determine the business portion of the refrigerator you can depreciate. Let's say your Time-Space Percentage is 40%.

$1,000 x 40% = $400. This is the business portion of your refrigerator.

2) How long do you depreciate the refrigerator?

All items costing more than $500 fall into one of these depreciation categories: office equipment (5 years), personal property (7 years), land improvement (15 years), home improvement (39 years), home (39 years) or car (5 years). For more information, see my article: "The Categories of Depreciation."

The refrigerator is considered "personal property" so it must be depreciated over 7 years. The phrase "personal property" here can be confusing. Essentially it means any property that's not attached to your home or land and is not office equipment. It doesn't mean property that is only personal. So, if you bought a $1,000 children's furniture set, it would be depreciated over 7 years as well.

3) How much is claimed as a depreciation deduction in the first year?

Now it gets more complicated. There are two ways you can depreciate seven year property. You can use the straight line method of depreciation or an accelerated method of depreciation.

The straight line method would give you approximately the same amount of depreciation deductions each year. You would claim 7.14% the first year; 14.29% for years 2-5; and 7.14% for year eight.

You might now say, "What is going on? Why are we depreciating the refrigerator over eight years? I thought were were using the seven year depreciation rule."

There is another rule that says you can't claim a full year's depreciation deduction in the first year, because you may have purchased the item in the middle of the year. Therefore, you only get a half a year's depreciation in the first year (no matter when you purchased it) and the other half at the end, or year eight. Aren't you glad you asked?

The accelerated method would give you higher depreciation deductions in the first few years and lower deductions in the later years. You would claim 14.29% in the first year; followed by 24.49%; 17.49%; 12.49%; 8.93%; 8.92%; 8.93%; and 4.46%.

Yes, this is also spread over eight years for the same reason as described above.

Which method should you use?

Because the accelerated method gives you deductions faster, it's almost always better to use this method. A deduction this year is worth more to you than a deduction next year, because you can use the money now or invest it.

So, using the accelerated method:

$1,000 x 40% = $400 x 14.29% = $57.16 first year depreciation deduction.

4) Where is my depreciation deduction claimed?

IRS Form 4562. In this case, seven year property is claimed on line 19c.

We're done!

Additional information

If you use personal property (or office equipment) more than 50% for your business, you can use the Section 179 rule and deduct the business portion all in one year, rather than depreciating it. So, for example, if our refrigerator was used 55% for the business, we could deduct $550 ($1,000 x 55% = $550) in the first year on IRS Form 4562, Part I. See my article, "The Section 179 Rule: A Powerful Way to Cut Your Taxes."

To use a business percentage other than your Time-Space Percentage for items used for both business and personal purposes, you must keep several months of records that show the actual business use. See my article, "How to Calculate an Actual Business Use Percent."

Is it worth it?

Some tax professionals tell providers that it's not worth depreciating a refrigerator to get only a $57 deduction the first year. This is bad advice. Over the course of eight years you will get a $400 deduction! Also, even a $57 deduction will reduce your taxes in the first year, so why not get it? It's your money. Lastly, you may have purchased other items besides a refrigerator and therefore your depreciation deduction will be higher.

My annual book Family Child Care Tax Workbook and Organizer has a long chapter explaining all of the depreciation rules in detail. It shows you how to calculate your depreciation deduction and where to put it on your tax forms.

If you use a tax preparer, let that person look at your receipt for the refrigerator and calculate your depreciation deduction.

Note for Minute Menu Kids Pro users

This software allows you to label and track items you purchase that cost more than $500. Although it won't calculate your depreciation deduction, it will organize these expenses so your tax professional (or you) may more easily fill out your tax forms.

13 Tax Questions Answered

The April 15th tax deadline is almost upon us. Here are some tax questions I've received from family child care providers recently:

1) Can I deduct my monthly mortgage payment?

-No. You can deduct your mortgage interest on IRS Form 8829 Expenses for Business Use of Your Home, line 10, column b (indirect expense). If your Time-Space Percentage is 35% you would deduct 35% of your mortgage interest on Form 8829 and 65% on Schedule A if you itemize.

You are able to capture the principle payments (that are part of your monthly mortgage payment) when you depreciate your home on Form 8829. See my article "How to Depreciate Your Home." 

2) Can I deduct 100% of my family child care union dues?

-Yes. In some states family child care providers have organized into unions and pay monthly union dues. These expenses can be deducted on IRS Form Schedule C, line 17 Legal and Professional Services. Some child care providers are not a member of a union, but are having "fair share" fees deducted from the payments they receive from the county for caring for children from subsidized families. You cannot deduct these "fair share" fees as a business expense. Instead, you are receiving less income and, as a result, you will pay less in taxes.

3) Can I deduct expenses for lawn maintenance such as a lawn mowing service or landscaping service?

-Yes. Multiply the cost by your Time-Space Percentage.

4) I bought some clothes (t-shirts, gloves, coats) for my day care children. Can I deduct this?

-It depends. If these items are given to the children for them to take home they would be considered "gifts" and are subject to a limitation of $25 per child, per year. There is a difference between a "gift" and an "activity expense." See my article on this. If these items were purchased for the children but kept in your home so they can be used by other children, then there is no $25 gift limitation and the items could be fully deducted as an activity expense.

Image credit: www.pamsclipart.com

5. If the clothes are used for daycare purposes (i.e. extra gloves for when theirs get too wet, t-shirts for extras when they get soiled, extra coats for those cold days when the parents bring them in a spring jacket etc...) wouldn't the clothing then be 100% deductible? 

 Yes, if you kept the clothes. No, if the children took home the clothes for good. I'll rewrite this section to make this point clearer.

6. We are planning on fencing on our entire front lawn, making it a nature exploration area for daycare. Can this entire expense be used as daycare since it will be used for daycare purposes only.

 It would be hard to argue that a fence in a front yard is only used for daycare, unless you have no young children of your own and you never use the front lawn area for personal purposes.

7. Will "fair share" dues be deductible if they are assessed against providers who are not receiving money from the county?
(Can the unions force us to pay these dues?)

Each state has its own rules about how they handle "fair share" payments. If the state makes you pay a "fair share" fee out of your pocket, then it's deductible. But, most states take the "fair share" payment out of the subsidy check before  the provider receives it. In this case, the provider is getting less in payments, reporting less in income and paying less taxes. There is a difference between union dues and "fair share." Unions cannot force providers to join the union or pay union dues. Fair share fees represent the costs associated with the union negotiating with the state to increase payments and provider other services and resources to all providers, those who are union members and those who are not. In most states who set up fair share fees, they are not voluntary.

8. So, for providers who are NOT taking subsidized families, is it your understanding that the union CAN make providers pay them the "fair share"? I'm in MN.

We don't know yet if the union will represent any providers in Minnesota, so I can't answer your question at this time. I don't know what the outcome will be. You can only be charged a fair share if the union is representing you. Whether or not the union will represent providers who do not care for subsidized families is not clear yet.

9. We are an small Day care for 6 children, What Document should we give to the parent to do their taxes? Should we give to them an account statement with the total that they paid for year o every three month?

Give parents an end-of-year receipt that indicates how much they paid you for the year. Give them your Employer Identification Number (EIN) and have them sign one copy that you keep for your files. There is no particular form to use when creating this receipt. You could use IRS Form W-10 and add to it how much the parent paid.

10. How will you do the deduction for a child care provider living in a movable home and paying mortgage for it, and also paying rent for the land? How many years we have to use for the movable house amortization?

You must depreciate the mobile home over 39 years. Deduct the time-space% of the rent on Form 8829.

11. Regarding Mortgage Interest on form 8829, my tax preparer - had entered it on line 16b "Excess mortgage Interest" I told her it should be on line 10b. She said it doesn't make any difference? Is that correct?

It won't make any difference since they are both multiplied by your time-space %. So, don't worry about this.

12. I pay rent where I live, am I able to deduct it with time-space%?

Yes, you can deduct the time-space% of rent, whether you rent a house or apartment.

13. Can I deduct the cost of dental insurance as a "self employed health insurance premium"? According to Turbotax, i can get a credit (as long as I show a profit) for health insurance premiums for me and my family. But, i wasn't sure if dental insurance was included. Turbotax wasn't clear on that.

Tom Copeland - www.tomcopelandblog.com

Business liability insurance for child care.

The Cost of Business Liability Insurance Is Money Well Spent

By Tom Copeland. Posted with permission.

Last week a provider called me in tears because she had lost her license.

Her dog bit a child in her program (with no serious injury) when her back was turned for ten seconds. The police investigator concluded that it was an accident.

But her licensor suspended her license anyway and the provider is now appealing her decision. Since this is a serious matter, I recommended that she hire an attorney to defend her. I asked her if she had business liability insurance because some insurance policies provide money for a lawyer in these situations.

She didn't have the insurance. She is single, cares only for subsidized children, has no money other than a $90 a month pension and can't afford to hire a lawyer. I referred her to some organizations that might be able to provide free legal help.

Over the years I have heard from many other providers in similar situations who face the loss of their license, paying thousands of dollars for a child's medical expenses, or a lawsuit from parents. See my article "The Real Risks in Family Child Care." Note: not all policies will pay for legal defense to appeal a negative licensing action.

Business Liability Insurance

These are all situations where providers who have business liability insurance could get help and not have to worry about paying out money to parents.

But, it's a tragedy that a majority of family child care providers do not have business liability insurance.

Perhaps the biggest reason why child care providers don't have this insurance is because they don't feel they can afford the cost.

What does this insurance cost? $400, $500, $1,000, or more per year?

The cost of business liability insurance will vary depending on three main factors: the state and town you live in, the amount and type of coverage you purchase, and the number of children in your care.

I contacted several insurance agents around the country and here are some examples of annual policy costs:

* Wisconsin - $1 million per occurrence/$2 million aggregate; $10,000 medical, child sexual abuse and professional liability coverage; 12 children: $585

* Pennsylvania - $1 million per occurrence/$3 million aggregate; $5,000 medical, professional liability, $300,000 child sexual abuse; 8 children: $680; for 14 children $945

* Indiana - $1 million per occurrence/$3 million aggregate; $10,000 medical; $1 million child sexual abuse; $1 million professional liability; $20,000 business property, 12 children: $653

* Washington - $1 million per occurrence/$3 million aggregate, professional liability, $50,000 child sexual abuse; $5,000 medical; 12 children: $560

* Minnesota - $500,000/$1 million; $500,000 child sexual abuse; $500,000 professional liability; $10,000 medical; dog and cat coverage; 12 children: $573

As you can see, the costs can vary. And it can be hard to compare policies when they offer different coverages. You should be choosing a policy based on what it coverage, not on its cost. You can expect that the more your policy covers the higher will be its cost.

For example, in California you can get a policy that covers $500,000 per occurrence/$500,000 aggregate and costs $426 for 8 children. If you doubled the coverage it would cost you only $152 more. That's a small price to pay for an extra half million dollars of coverage! See my article, "When Trying to Save $8.25 a Month is a Mistake."

I recommend that you get as much insurance as you can afford. Ideally, you should have $1 million per occurrence (maximum pay out for each incident) and $3 million aggregate (maximum pay out for the life of the policy). You also want coverage for professional liability, child sexual abuse, and medical expenses. See this article for a checklist of coverages.

Your homeowner's insurance policy will not cover you for any accidents that happen while caring for children.

Paying for Insurance

I strongly believe that all child care providers should have business liability insurance. Paying for it is a cost of doing business. You can deduct 100% of this cost as a business expense. So, if you are in the 30% tax bracket and the policy costs $585, your actual cost after taxes is $410. That's equal to $1.10 per day.

Many insurance companies will allow you to pay the premiums on a monthly or quarterly basis. Some providers pass on part of the premium costs to parents. If your policy cost $600 and you care for six children, you could ask parents to pay an extra $50 when the annual premium came due and this would reduce your cost to $300 ($210 after taxes).

Parents may be willing to help pay for this insurance because they know it will cover their medical costs if their child is every injured.

I've posted an insurance directory above where you can find a number of companies who offer insurance in your state.

Don't let a few hundred dollars get in the way of protecting yourself and your business from financial disaster.

Thanks to the following insurance agents: Debe Marofsky, Affiliated Insurance; Don Morgan, Morgan Insurance; Beth Jones, First Choice Insurance Services; Kristi Olsen, Freisinger Insurance; and Jordan Silverman, DCI Insurance.

Tom Copeland - www.tomcopelandblog.com

Image credit: www.enhancedinsurance.com

For more information about business liability insurance, see my bookFamily Child Care Legal & Insurance Guide.

Household inventory

It's Time to Do a Household Inventory

By Tom Copeland. Posted with permission.

Have you recently conducted a household inventory where you listed and photographed every item in your home?

There are two reasons why every family child care provider should do so.

First, there are thousands of dollars worth of tax deductions sitting in your family child care home, waiting for you to report them on your tax return. 

Second, your inventory will be extremely valuable when making an insurance claim if your property is ever damaged or destroyed in a fire, tornado, hurricane, flood, or if your home is burglarized.

The picture above is of a family child care provider's kitchen damaged by a grease fire.

Business Deductions

You are entitled to deduct household items you use in your business.

Such household items include your washer, dryer, refrigerator, stove, television, beds, tables, chairs, lawn mower and snow blower. In addition to furniture and appliances, you can also include rugs, lamps, bedding, silverware, pots and pans, curtains, towels, tools, and so on.

Anything that you owned before you went into business that is now being used in your business can be claimed as a business expense by depreciating it. Anything purchased after your business began that costs less than $200 may be deducted in one year. Items costing more than $200 may have to be depreciated.See my article about a new "$500 rule."

Conduct an inventory of all household items by writing them down. This job can be made easier by using my Family Child Care Inventory-Keeper. It is an easy-to-use log that enables you to track your household items by room.

Since you probably don't have receipts of these items, take pictures to support your deduction.

Take enough pictures in each room so that you can identify individual items.

Estimate each item's value as of the day you first started using it in your business. Use thrift store or garage sale prices. You don't need a receipt to depreciate these items.

This may seem like a lot of work, but it is well worth your time.

Let's say the value of all your household items was $10,000. If your Time-Space Percentage was 40%, you can depreciate $4,000 ($10,000 x 40%) as a business expense over 7 years. This represents approximately $570 in tax deductions each year for 7 years.

See also my article, "Depreciating the Contents of Your Home: The Right Way and the Wrong Way."

Many child care providers fail to take advantage of the tax rules that allow you to depreciate household items they owned before their business began. Turn over your inventory list to your tax preparer and have him/her calculate the depreciation deduction. 

If you do your own taxes, use my annual Family Child Care Tax Workbook and Organizer to calculate your deduction.

Insurance Protection

You want a photographic record of everything in your home so that you can make a claim for damage or loss with your insurance company.

Take pictures of everything in each room in your home (including your basement and garage). Open desk and dresser drawers, kitchen cabinets and take pictures of everything inside (particularly of valuable items such as jewelry). Take pictures of your closets, your backyard (patio chairs, grill, swing sets, etc.), and your laundry room.

Put these pictures on a flash drive and put them in a safe deposit box. (The cost of the flashdrive and part of the cost of the safe deposit box can be a business expense!)

Yearly Inventory

It's a good idea to conduct a written inventory and take pictures of everything in your home once a year.

Why? Doing so will capture new items you purchased.

In addition, it will help you identify items that you no longer have. This can help you if you were depreciating an item that is thrown away or destroyed. In this situation you can deduct the remaining amount of depreciation at the end of the year.

For example: Let's say you were depreciating a $1,000 couch (and your Time-Space % was 40%) over seven years and it is wrecked after 4 years. You would still have about $125 in depreciation (for years 5-7) that you can claim in the year it was wrecked.

Conclusion

You've probably heard before the importance of conducting an inventory of household items and taking pictures of everything in your home. You know you should do it. Make this year the year you do!

Note: As I write this article, I haven't done an inventory of my home for insurance purposes! I've promised myself to do this by the end of 2014!

Tom Copeland - www.tomcopelandblog.com

Image credits: velizaschildcare.com, www.mummymusingsandmayhem.com,savannahnow.com

See my Family Child Care Inventory-Keeper to help you track your inventory.