I.R.S. Memo Seen as a Threat to Family Child Care

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A recent Internal Revenue Service memorandum that lays out a more stringent formula for calculating business deductions than the one now used by most day-care providers who operate at home could undermine the availability and quality of so-called family child care nationwide, experts are warning.

The "technical-advice memorandum," which was issued by i.r.s. officials in Washington to clarify questions that arose in an audit of a day-care provider in St. Paul, suggests that such operators who claim a business deduction on their federal income-tax returns must be prepared to show how much time children spend in each room of a provider's house per day.

Agency officials say the memorandum applies only to the Minnesota case and does not have the force of a legal precedent. They also maintain the advice it contains is consistent with guidelines outlined in the tax code and in i.r.s. publications.

But because the memo appears to challenge the method most commonly used by family-child-care providers and their tax preparers to claim business deductions, experts in the field say it could have national repercussions.

Family day care, because of its convenience for parents, low child-staff ratios, and homelike atmosphere, is one of the most popular forms of care, especially for infants and toddlers. The Children's Foundation, a national child-care advocacy and training organization, estimates that there are about 225,000 regulated family-day-care providers in the United States, a figure the group says reflects only about a quarter of all providers who use their own homes to care for other people's children.

Experts say Minnesota has an estimated 13,000 licensed family-day-care providers, the third-largest contingent in any state.

If the i.r.s. interpretation--which may be appealed by another St. Paul provider undergoing an audit--is upheld, "it is going to make a big difference to an awful lot of providers," Kay Hollestelle, executive director of the Children's Foundation, said last week.

"This is going to be a major upset. People are going to leave the profession for this reason," predicted Carol C. Ploeckelmann, the St. Paul provider whose tax preparer initially sought clarification from Washing4ton on a 1990 audit ruling on Ms. Ploeckelmann's 1988 tax return.

Since the i.r.s. memorandum surfaced earlier this month, Minnesota providers have sought help from their Congressional delegation in finding a legislative remedy. Senator David Durenberger, a Minnesota Republican who serves on the Senate Finance Committee, was expected to introduce a bill late last week to address the issue.

The Congress in 1977 limited most home-business deductions to portions of the home used "exclusively" for business purposes on a regular basis.

Recognizing that "it is not practicable to cordon off a portion of the residence to be devoted exclusively to provide day-care services," however, the Senate Finance Committee made an exception for home day care to allow deductions for rooms that are used for both day care and personal use.

Under guidelines laid out by the committee, providers must calculate the amount they can deduct using a "time-space formula" that factors in the percentage of total square footage of the home used for child care and the number of hours it is used for that purpose.

"The commonly accepted way was to say whether or not a room was used on a regular basis," said Tom Copeland, an information specialist for Resources for Child Caring, a nonprofit organization based in St. Paul that provides child-care resource, referral, and training services as well as tax information for providers.

In what Mr. Copeland and others characterized as the first interpretation of its kind, the memorandum sent from the main i.r.s. office to the revenue agency's district director in St. Paul set out a formula specifying how much time per day each room was used in the home in question and stated that, "where different rooms in a residence are used for business purposes for different periods of time each day, we believe the approach of the ruling should be applied to each room on the basis of its actual business use."

Mr. Copeland said the interpretation could create a "recordkeeping nightmare" for providers.

"Up until now, it has never been required that you have to have day-by-day, hour-by-hour documentation," Ms. Hollestelle added. "That seems to be what this case is coming down to."

"If it stands," Mr. Copeland said, "this means a dramatic change across the country."

To use the approach laid out in the memorandum, providers interviewed last week said they would have to keep detailed records tracking children's movements fromroom to room each day.

"What the i.r.s. is telling me and all of us being audited now is that unless a child is in each part of a room all day long, we can't claim 100 percent of the space," said Pamela Uphus, a St. Paul provider who is considering appealing an audit of her family-day-care service based on that interpretation.

"How am I going to run around keeping records when kids move like lightning?" she asked.

"When you've got six children in different rooms at different times," Ms. Ploeckemann observed, "no one will have the time to keep a log of what hours children are in what room."

The providers also said time spent compiling such data would distract them from interacting with children and planning their programs, thus compromising the quality of care.

"I think we're getting away from the reason we provide day care in our homes," Ms. Ploeckelmann said.

Mr. Copeland of Resources for Child Caring also argued that the interpretation "raises many more questions that are unanswered," such as how to apply utility costs in rooms where children spend only a portion of the day and how to account for time spent playing outdoors.

Beyond practical considerations, experts said that at a time when child care is already falling short of need, stricter tax rules could sway providers to raise their fees, go "underground," or abandon the profession.

Qualified providers "could get a job somewhere else--is that what [the tax officials] really want?" said Beth Mork, president of the Minnesota Licensed Family Child Care Association.

"A worst-case scenario," Ms. Hollestelle of the Children's Foundation said, "would be that a provider in the past who had been licensed and was willing to meet all of the rules under the i.r.s. for handling their business will give that practice up, go underground, and no longer even bother with a license, never mind paying taxes."

Ms. Mork also noted that her organization had unsuccessfully sought clarification from the i.r.s. on issues ranging from the time-space formula to how to deduct for food expenses--issues on which she said agency interpretations have run "across the board."

Although they would not discuss details of the St. Paul case, i.r.s. officials said last week that the memorandum did not signal a major shift in policy, and that the reaction from care-givers "exaggerated" its impact.

"I'm not seeing how this is a major change--it is not even clear as to if it is a change," said Don Roberts, an i.r.s. spokesman in Washington. "A taxpayer claiming a business expense has to be able to support what is being claimed."

Eric Smith, an agency spokesman in St. Paul, added that the memorandum should not have come as a surprise to providers, because there have been "discussions and disagreements" on how to interpret the law on such matters for some time.

An i.r.s. publication offering guidance to taxpayers on filing their 1990 income-tax returns advised day-care providers that they could compute deductions for specific rooms based on the percentage of business use on a weekly or a yearly basis.

Even if neither the tax code nor previous i.r.s. documents expressly required hour-by-hour records, Mr. Roberts said, providers "have to start from something" to compute a "typical percentage" of the home4used for child care.

While care-givers may not have to "sit around with a logbook for 365 days a year," he said, "they may need to keep some records for a period of time to determine what that typical percentage is" and arrive at an average.

But providers said it would be difficult to calculate the "typical" use of each room without keeping a daily log, since use can vary widely from day to day and season to season.

Mr. Smith stressed that the memorandum addressed "a particular situation under a particular set of circumstances," and that the i.r.s. "is continuing in looking at these cases to be reasonable in looking at whether a person reasonably determined the percentage being used for business."

Mr. Roberts said the i.r.s. would make the memorandum available for public inspection later this year--without identifying the taxpayer involved--but that it would still apply only to that taxpayer.

"If in fact we wanted to establish a course of change or promulgate new rules," he said, "that's not the way we would do it."

Meanwhile, the bill being drafted by Senator Durenberger would sidestep the i.r.s. memo by permitting providers to claim the full deduction for any room that was used for child care for at least an hour a day, including preparation time.

Although Ms. Ploeckelmann and Ms. Uphus had claimed deductions for about a third of their indirect household expenses related to child care--a share experts say is average for family day care--the irs, based on its recent interpretation, limited their claims to less than 10 percent.

Mr. Copeland estimated that similar principles have been applied in audits of more than 30 providers in the St. Paul area in the past year.

He also estimated that the formula outlined in the memorandum would cost family-day-care providers, on average, an extra $200 in taxes per year, an amount he called "significant" for those struggling to make ends meet.

Because child care "is not one of the more lucrative professions," said Barbara Taylor, president of the National Association for Family Day Care, the net effect on providers could be "disastrous."

Despite growing public awareness of the preventive value of "early care and nurturing of children," she added, providers have "so many disincentives now, it's amazing there are as many in the system as there are."

Vol. 10, Issue 31

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