"I went into my audit with great confidence and came out crushed," she wrote me. The auditor told her she owed about $2,800 in taxes.
Bethany had claimed that she used her toddler room and basement exclusively for her business on her 2009-2011 tax return. I first wrote about Bethany's case in my article "How to Defend Your Exclusive Use Room." For a discussion of the exclusive use rule, see my article "How to Claim the Exclusive Use Rule."
This uniqueness can create problems when child care providers are audited by the IRS and the auditor does not understand these rules. This is what happened to Bethany.
The auditor said she could never claim an exclusive use room for two reasons. One: once a day care child leaves a room it is no longer used for business purposes. Two: there is no way to prove that the child care provider's family does not use these rooms when day care children are not present. In addition, the auditor claimed that Bethany must report as income reimbursements she received from the Food Program for her own child. See my article on this last point.
I wrote a letter to the auditor on Bethany's behalf and refuted the auditor's statements.
At one point the IRS auditor told Bethany that she couldn't claim exclusive use rooms because of what was written in IRS Publication 587 Business Use of Your Home. There is nothing in that publication that says what the auditor thought it said.
It took my letter and Bethany's insistance before the auditor finally read the instructions to IRS Form 8829 Expenses for Business Use of Your Home. There it explains how to calculate the Time-Space Percentage when there are exclusive use and regular use rooms in the same home.
At last the auditor agreed with Bethany. As a result, her tax bill dropped from $2,800 to $1,105.
Bethany had inadvertently claimed all of her basement as exclusive use space, even though she had a laundry room and bathroom in the basement that were used by her family. Her initial Time-Space Percentage was 74%. The auditor originally would only allow 48%, but in the end accepted a revised 59% based on an exclusive use playroom and part of the basement.
Note: some family child care providers and tax preparers are reluctant to claim a Time-Space Percentage higher that around 40% because of the fear that the IRS won't accept a higher percentage. This case is one of many examples where a provider has successfully claimed a higher percentage.
Bethany wrote me a letter of thanks, saying, "I don't think I could thank Tom enough for giving me the necessary information and encouragement to fight the IRS. Armed with this information from Tom I was able to show the IRS... I was still in the right... and I won."
If you are being audited about your exclusive use room you may want to use the arguments in my letter to defend yourself. Before you do, please contact me to get the latest information on this tax issue.
I continue to help child care providers who are being audited by the IRS through my work with the National Association for Family Child Care. If you need help, please contact me at email@example.com or 651-280-5991.
Image credit: Bethany's exclusive use toddler room
For more information on how to calculate your Time-Space Percentage when you have exclusive and regular use rooms, see my book Family Child Care Record Keeping Guide.