Daycare Business Tax Preparation: Expenses, Payroll, and Records

Child care is one of the few industries where the tax code has special rules for running a business out of your home. Providers who understand them can deduct a legitimate share of household costs. Providers who do not often under-deduct, or deduct without records. Either way, careful documentation is the difference.

What counts as income

• Fees paid by parents, including registration, late pickup, and supply fees.
• Payments from state or local child care subsidy programs.
• Reimbursements from the Child and Adult Care Food Program or similar food programs, which are generally income, offset by the food costs you incur.
• Grants and other program payments, depending on their nature.

Home daycare: the time-space percentage

The business use of home rules normally require space to be used regularly and exclusively for business. Day care providers have a special allowance: space used regularly for child care can qualify even if it is also used for family purposes, as long as other conditions are met, including being licensed or exempt from licensing where required. The deductible portion is generally based on the share of the home used and the share of time it was used for the business, the so-called time-space percentage. IRS Publication 587 explains the method. Keep a log of hours of operation, the rooms used, and square footage.

Typical deductible expenses

• Food for children in your care. Providers in a food program may use standard meal allowance rates rather than tracking actual receipts, subject to rules. Confirm which method you may use.
• Toys, books, craft supplies, and equipment.
• Cleaning supplies and household supplies used for the business.
• Insurance, licensing, background checks, and training.
• A share of mortgage interest or rent, property tax, utilities, repairs, and depreciation for home providers.
• Wages and payroll taxes for assistants.
• Vehicle costs for business trips, such as field trips or supply runs, with a mileage log.
• Advertising, software, and professional fees.

Provider identification and parents' credits

Parents who claim the child and dependent care credit, or use a dependent care benefit through an employer, need the provider's name, address, and taxpayer identification number. You are generally required to supply this, and the IRS has a form for providers to give parents. Providing it also puts your income on the record, so it must appear on your return. Failing to cooperate can complicate your clients' taxes and invite attention.

Staff and payroll

Assistants, substitutes, and relief staff are usually employees. Payroll withholding, employer taxes, unemployment insurance, and workers' compensation apply. Family members you employ have special rules. See small business payroll services and W-2 vs 1099 classification.

Records to keep

1. 1Daily attendance sheets showing each child's hours.
2. 2Meal counts and menus if you use standard meal rates.
3. 3Receipts for supplies, food, and equipment.
4. 4A home use schedule with square footage and hours.
5. 5Licensing documents and inspection records.
6. 6Payroll records and Forms W-2.
7. 7Copies of the provider ID form given to parents.

Entity and taxes

Most home providers file Schedule C, and pay self-employment tax with quarterly estimates. Larger centers may use an LLC or S corporation. See Schedule C tax preparation, first-year LLC taxes, and quarterly estimated taxes for LLC owners.

Common daycare tax mistakes

• No attendance records, so the time-space percentage cannot be supported.
• Deducting 100% of household costs.
• Leaving food program reimbursements off the return.
• Not reporting subsidy payments.
• Paying staff in cash without payroll.

Our tax preparation service prepares returns for home and center-based providers. To schedule a consultation, tell us whether you operate from home or a center, your state, and whether you take part in a food program.