If you're a day care provider and other home business owner, you may not think you hired any independent contractors, but what about your lawn service? Your window washer? Your handyman? Or the guy who shovels your driveway?
These folks aren't providing services directly to your business, but they do indirectly, if you are taking a home office deduction. If you want to deduct a percentage of what you pay them on your tax return, I recommend that you give a 1099-MISC to any home service provider you paid at least $600 to over the course of the year.
Giving 1099s to home service providers
According to Tom Copeland, child care providers should give 1099s to home service providers paid $600 or more during the year. This advice applies just as well to other home-based businesses.
The idea of giving 1099s to home service providers was new to me when I first corresponded with Tom on this subject. I don't believe it is required, but I agree with Tom that preparing a 1099 is the best way to safeguard your tax deduction.
I asked "TaxMama" Eva Rosenberg for her opinion and she agrees with Tom:
From the standpoint of the compliance audits IRS is doing now, I can see an aggressive auditor disallowing a deduction because there was no 1099 or W-2. And frankly, if you were to appeal, you'd probably lose - since you're taking these expenses (even if only part of the expense) as a business deduction.
IRS wants to close that tax gap. And these maintenance-type workers are often a big part of the unreported economy.
The potential cost of doing nothing
I didn't start giving a 1099 to my house cleaning service until a few years ago. Before that, a agreesive auditor could have disallowed the portion of my house cleaning costs deducted as a business expense on my home office form. I would have immediately owed additional income and self-employment tax, plus penalties and interest.
My total out-of pocket to the tax authorities would vary, but considering the size of my home office, losing this deduction could easily cost me $150. Closer to $300 if I had the home office percentage of a typical day care provider (30-35%). Even more with a business percentage higher than 35%, which is common for family child care providers. (The Form 8829 business percentage for child care providers is also known as the time/space percentage.)
1099s are easy to prepare
The good part is that 1099-MISC forms are not at all complicated or expensive to prepare. I am confident that you will agree. It takes only a few minutes to fill out a 1099-MISC and the 1096 transmittal form and you can get 1099 forms free from the IRS, but expect it to take about 10 business days. (1099 forms cannot be downloaded, because they are special red scannable forms.)
The real problem can be getting your service worker's tax id number and address information. Some workers insist on being paid in cash. In that case, you do the math (or have your tax pro do it for you) to see how much it would cost you to lose the deduction in an audit. Then you ask yourself if it's worth continuing to use the person's services or if you are better off looking for someone else.
Don't forget direct service providers
Most workers providing services directly to your day care business are considered employees, but double check to see if you may have hired a tutor, puppeteer, storyteller or other professional activity-provider. You may also occasionally hire someone to provide substitute child care services. You should definitely give these folks a 1099-MISC if they were paid $600 or more during the year. Direct (100%) business expenses give you the biggest tax savings and they're well worth protecting.
Observe the situation carefully if you hire a substitute caregiver. To be an independent contractor, such a person should advertise to the public, give you a tax id number, provide services to multiple providers, and have a business contract for you to sign. This is rare. In general, caregivers you hire will be considered your employees.
Ready to file a Form 1099-MISC?
Follow this link to my blog entry providing Step By Step Instructions for Preparing 1099s.
Last updated 18 June 2012