Tax Laws

Licensed child care providers, like all business owners, are required to meet certain tax obligations, such as paying federal and state taxes. The legal structure of the business will determine the amount of taxes you will pay and the forms you will use.

Reporting business taxes can be a very complicated, tricky matter. This section is not intended as a substitute for advice by a tax specialist, nor does it list all the forms that must be filed by each entity. For additional information on these and other forms, and to avoid costly errors, contact a tax specialist or the IRS.

Sole Proprietorship

Each year, you will use Schedule C of the basic Form 1040 Individual Tax Return for reporting your business income and expenses. Good record keeping is essential for filling out these forms.

Income

Keep a ledger of all money you are paid for child care, whether in cash or by check. Record each payment, especially cash, immediately to avoid overlooking a payment and causing a bookkeeping error. Your ledger should include:

• Clients' names
• Date of each payment
• Period covered by the payment
• Amount paid
• Receipt number

Payments should be deposited in your bank account and funds for daily operations should be withdrawn by check only. It may be a good idea to open a separate bank account for your business. This makes it easier to monitor business income and expenditures and will certainly make reporting your business taxes easier.

Expenses

All payments that you make for the child care center, whether by cash or by check, are business expenses. To maintain adequate records of these expenses, always save your receipts. The better your records, the easier it will be to complete your tax forms at the end of the year.

Certain items may qualify as a tax deduction if these purchases are made solely for your child care center:

• Toys and activity supplies
• Food for the children in your care
• Playground equipment
• Wages for assistants or substitutes
• Advertising
• Legal and professional services for your business
• Office and record-keeping supplies
• Insurance for your business
• Child care-related travel (a set rate per mile; the allowable amount will vary according to your location)
• Typewriter and/or computer
• Utilities

Depreciation

Expenses that benefit both your child care center and your family will not ordinarily qualify as a tax deduction. But tax regulations do permit you to write off any specific area of your home used strictly for business purposes.

Other forms that you may need to comply with federal regulations are:

1. Schedule SE Social Security or Self-Employment Tax

2. Form 4562 Depreciation

3. Form W-2 Wage Statement

4. Form 1040ES Federal Estimated Tax Payments and State Estimated Tax Payments

5. Schedule C, Form 1040 -- Individual Tax Return

You may find these forms at http://www.irs.gov/

Corporation

A corporation's taxable income reflects deductions for costs of doing business. Corporations are taxed on a graduated scale, with the minimum rate being 34 percent. Form 1120 is used to report the annual income of the corporation.

Items deductible under proprietorships are also deductible for corporations. However, if you operate a child care center in your home, certain items are deductible only to the extent that such costs relate to the operation of the child care center. These items include:

• Heat, water and electricity
• Costs of staff salaries unless they are unreasonably high
• Depreciation, which is deducted in computing taxable income

Distribution of profits to shareholders, made through dividends, is not deductible by the corporation. However, these dividends are subject to double taxation in that they are not deductible by the corporation (i.e., they are paid with after-tax dollars) and shareholders are taxed on receipt of dividend distributions.

Partnership

A partnership is a pass-through entity because the partnership itself pays no tax but the income is passed on to each individual partner. Each year the partnership must file an annual information return, Form 1065, Section 6031(a), with the IRS. In addition it must prepare Form K-1, Section
6031(b), which spells out each partner's share of profits, gains, losses, deductions and credits. These amounts are reported on each partner's tax return.

S-Corporation

S-corporations are hybrid entities with characteristics of both corporations and partnerships. They do not pay taxes but must file annual information returns and prepare statements showing income, gain, loss, deduction or credit allocated to each shareholder for the taxable year. These amounts are reported on the shareholder's tax return (Form 1040 Schedule C for an individual).

Tax-exempt Child Care Center

To qualify for certain federally funded programs, you will have to establish a nonprofit child care center, which will make you eligible for tax-exempt status. In a nonprofit organization, any money left after expenses is returned to the operation of the child care center (e.g., salaries, remodeling, etc.). You must, however, file an application and meet IRS eligibility requirements to claim this status.

Some of the advantages of tax-exempt status are:

• State sales taxes do not have to be paid
• Contributions to the child care center are tax deductible for any donor, whether made by an individual or a foundation
• Grants are easier to obtain from both private and public sources

To qualify for tax-exempt status, incorporation is necessary. The process for incorporation varies widely in each state, but generally requires that bylaws be written and a board of directors elected. Information on incorporation can usually be obtained from the secretary of state's office or the department of corporation. A small fee is usually required.

Once you have filed your articles of incorporation and fulfilled all other state requirements, you can file for tax-exempt status. Remember, even with federal tax exemption, you are still required to pay state taxes. To receive state exemption, you must file with the appropriate state agency. The state, however, will not give an exemption until the federal exemption has been granted.

Before deciding to operate as a nonprofit organization, contact a lawyer. Sound legal advice will help you make the right decision.