The start up rule

How to Handle Expenses Before Your Business Begins: The Start-Up Rule

By Tom Copeland, posted with permission

Let’s say before your family child care business began you bought a computer, a dining room chair, a toy and a smoke detector.

What are the rules to follow in deducting these items?

The answer depends on the cost of an item and whether or not you bought it to help you start your business.

Items Purchased to Help Start Your Business

Items costing less than $2,500
If you bought an item for less than $2,500 to help you start your business, it’s considered a start-up expense. Examples include advertising, children’s books, business name registration fees, first aid kit, supplies, training workshop fees, and so on.

Basically, if you are buying small items to help you to get ready to open your business, it’s a start up expense. 

You can deduct up to $5,000 of start-up expenses in the year your business begins. For example, let’s say a provider buys $1,000 worth of small toys (none costing more than $100 each), $50 for a child development workshop, $80 for storage boxes, and $300 in arts and craft supplies in the summer of 2015. If she starts her business in July 2016 she will be able to deduct the full $1,430 on her 2016 tax return. This assumes she is using all of these items 100% for her business. Start-up expenses in excess of $5,000 must be amortized over 180 months (15 years).

If you did not use the item at all until your business began, deduct the purchase price. But what happens if you personally use any of these items before your business began? In this case, you must estimate the fair market value of the items at the time you business did begin before you deduct it.

For example, if you personally used the storage boxes ($80) in December 2015, you would estimate their value in July 2016 once you began using them in your business. Perhaps they would be worth $50 by then. If you use the storage boxes for both business and personal use once your business begins, multiply the $50 by your Time-Space Percentage to determine your business deduction.

If you put the storage boxes in your basement and only began using them for your business in July 2016, you would deduct the full $80.

Items costing more than $2,500

If you buy items that cost more than $2,500 (computer, swing set, washer, dryer, furniture, etc.), you must depreciate them. Depreciation means you claim a portion of the cost as a deduction over a number of years.

Most household items are depreciated over seven years. For details on depreciation rules, see my article “The Categories of Depreciation.”

It doesn’t matter if you bought these items to help you start your business or not. In most cases you will have to depreciate them. (See my article that describes an exception to this rule.)

If you bought the item before your business began, use the value of the item when it is first used in your business.

Items Not Purchased For Your Business

Family child care providers will have a house full of furniture, appliances and hundreds of household items at the time their business begins. You are entitled to depreciate all of these items once they are used in your business. You must depreciate them, even if their original cost was less than $500.

If you purchase an item after your business begins that costs $2,500 or more, you must follow the regular depreciation rules.

You will gain a lot of business deductions if you do a household inventory of all items in your home before your business begins. See my article on how to do this.

Summary

Confused? Here’s a summary:

Items purchased before your business began to help you start your business
* Cost less than $2,500 – deduct in one year (start-up expenses limited to $5,000)
Example: $40 toy purchased in 2015 and first used in 2016 when business begins. Deduct in 2016.
* Cost more than $2,500 – depreciate
Example: $3,000 swing set purchased and used personally in 2013. Used for business and personal use in 2016. Estimated value when first used for business: $2,000. Depreciate using your Time-Space Percentage on $2,000 in 2016.

Items Not Purchased For Your Business
Estimate the value of the item at the time it is first used in your business and depreciate it. Apply your Time-Space Percentage if it’s used by your family and your business.
Example: $50 rocking chair and $400 freezer used both for business and personal use. Multiply by your Time-Space Percentage and depreciate both.

Although this is a relatively complicated issue, claiming start-up expenses and other deductions for items purchased before you started your business is well worth your time.

Tom Copeland – www.tomcopelandblog.com

Mistakes of your tax return.

Don’t Make These Mistakes on Your Tax Return

By Tom Copeland. Posted with his permission

Tax preparers can make mistakes.

Many mistakes are the result of not understanding the unique tax rules affecting family child care providers.

This is the time of year I hear from providers who have met with their tax preparer and have questions about whether their tax return has been done correctly.

Here are some of these mistakes:

Not entering hours on Form 8829 Expenses for Business Use of Your Home

One tax preparer counted all of a provider’s space as “exclusive” use space on line 1 of this form. As a result, he entered no hours on line 4. This would have been the correct way to fill out this form if it was any business other than family child care. All family child care providers must enter the hours they work in their home on line 4.

Not subtracting the value of land when depreciating the home

All family child care providers should depreciate their home on Form 8829. Line 36 is where to put the purchase price and line 37 is where to put the value of the land at the time of the purchase. Make sure there is a number on line 37.

Claiming 100% of household items such as supplies, as well as toys, repairs, etc.

Although providers can deduct a portion of hundreds of household items, they can’t deduct 100% of such items unless they are used 100% for your business. For shared business and personal expenses, use your Time-Space Percentage. When you are giving your tax preparer amounts that you spent on various items, be sure to indicate whether the amounts are 100% business or shared.

Not deducting items you are entitled to deduct

Yesterday a provider told me she was considering buying a generator for her home because the power goes off several times a year. Her tax preparer said she wouldn’t be able to deduct it. A generator is clearly an “ordinary and necessary” expense for a family child care provider. You can’t run your business without electricity and you don’t want food to spoil!

Recommending that providers not join the Food Program because they will end up paying more in taxes

This is terrible advice that I keep hearing about. Yes, your taxes will be higher if you join the Food Program, but you will have more money in your pocket after you pay these taxes. If parents paid you more money your taxes would also go up, but I doubt that you would refuse the money.

Depreciating items costing less than $2,500

A new IRS rule allows you to deduct in one year any item costing less than $2,500, rather than depreciating it. See my article on this.

Defend yourself

Don’t give up simply because your tax preparer says something you don’t agree with. Ask him/her to show you an IRS document that supports their position. See my article: Do You Know What is On Your Tax Return?”

The Child Care Business Partnership

I am learning about these tax preparer mistakes while helping members of The Child Care Business Partnership. One of the member benefits is that I can review a provider’s Minute Menu records and tax return where I regularly find these errors. Once identified, the provider can get them corrected and save money. To learn more about the benefits of membership, click here.

Tom Copeland – www.tomcopelandblog.com

Image credit: https://www.flickr.com/photos/fortrucker/