It’s a question that often causes confusion among family child care providers, Food Program (CACFP) sponsors, and even tax professionals: How should you report Food Program expenses? The straightforward answer is yes, Food Program reimbursements are generally considered taxable income for your child care business.
There is a notable exception. Reimbursements specifically received for your own children enrolled in your child care are not considered taxable income. IRS Publication 587, “Business Use of Your Home,” clarifies this point, stating, “Do not include payments or expenses for your own children if they are eligible for the program [Food Program].” This is because these reimbursements are treated as a “benefit” under Food Program regulations, similar to food stamps, and therefore not subject to taxation.
However, the method of reporting these Food Program reimbursements and related expenses on your tax return is where the confusion often arises. Let’s break down the recommended approaches and clarify how to accurately account for these funds.
Understanding the Two Methods of Reporting Food Program Expenses
The IRS has offered different guidance over time, leading to some ambiguity. Initially, IRS Publication 587 suggested what is known as the “netting method.” However, more recent guidance, particularly the IRS Child Care Provider Audit Technique Guide, recommends a different approach – separate reporting.
The Netting Method: An Older Approach
IRS Publication 587 states: “Reimbursements you receive from a sponsor under the Child and Adult Care Program of the Department of Agriculture are taxable only to the extent they exceed your expenses for eligible children. If your reimbursements are more than your expenses for food, show the difference as income in Part I of Schedule C. If your food expenses are greater than the reimbursements, show the difference as an expense in Part V of Schedule C.”
Essentially, this “netting method” means you only report the difference between your Food Program reimbursements and your food expenses. For example, if you received $4,000 in reimbursements and spent $5,000 on food for the program, using this method, you would report zero income and $1,000 of food expenses on Schedule C of your tax return.
The Recommended Method: Separate Reporting for Clarity
Despite the “netting method” described in Publication 587, a more recent IRS publication provides clearer and preferred guidance. The IRS Child Care Provider Audit Technique Guide, specifically designed for IRS auditors examining family child care businesses, recommends against the netting method. This guide, revised in 2009, advises: “If the provider receives reimbursement for food costs through the CACFP or any other program, the provider can report all the reimbursements under the income section of Part I of the Schedule C and then deduct the food expenses in full, which is the recommended method.”
The Audit Guide further explains the reasoning behind this recommendation: “The netting method is not a preferred method since an [IRS] Examiner will always be looking for the food reimbursement amounts. When you report the amount separately, the Examiner will more easily be able to account for the payments.”
Using the same example as above – $4,000 in reimbursements and $5,000 in food expenses – the recommended method dictates that you should report the full $4,000 as income on Schedule C and separately deduct the entire $5,000 as a food expense.
Why Separate Reporting is the Preferred Approach
While both methods technically result in the same tax liability, the IRS prefers – and recommends – separate reporting for several practical reasons:
- Transparency for Audits: IRS auditors are specifically trained to look for Food Program reimbursements. Reporting them directly as income makes it easier for auditors to track and verify these payments during an audit. The netting method can obscure these reimbursements, potentially raising questions or requiring additional clarification during an audit.
- Simplicity and Clarity: Separate reporting is arguably simpler to understand and implement. It mirrors how most other business income and expenses are reported – income is recorded, and expenses are deducted. This straightforward approach reduces the risk of errors and misunderstandings.
- Best Practice in Tax Accounting: Generally accepted accounting principles favor transparent and full reporting of income and expenses. Separate reporting aligns with these principles, providing a clearer financial picture of your child care business.
In practice, experienced tax professionals and those familiar with IRS audits in the child care sector consistently advise using the separate reporting method. It eliminates potential confusion and aligns with the IRS’s preferred approach, as outlined in their Audit Technique Guide.
Tax Implications: Netting vs. Separate Reporting – The Bottom Line
It’s crucial to understand that both the netting method and the separate reporting method will ultimately result in the same amount of taxable income and the same tax liability. The difference lies in how you present this information on your tax return, not in the final tax owed.
Consider our ongoing example:
- Netting Method: $4,000 Reimbursements – $5,000 Expenses = -$1,000 (Expense). You report $0 income and $1,000 food expense.
- Separate Reporting: $4,000 Reimbursements (Income) and $5,000 Food Expenses (Deduction). You report $4,000 income and $5,000 food expense.
In both scenarios, the net effect on your taxable income from Food Program reimbursements and expenses is the same. However, the separate reporting method offers greater clarity and is the IRS’s recommended approach.
If a child care provider was not participating in the Food Program, they would simply report zero income from reimbursements and deduct their eligible food expenses. Joining the Food Program effectively increases their taxable income by the amount of the reimbursements they receive, while also helping to offset food costs and provide nutritious meals to children in their care.
Don’t Fall for Misinformation: Report Your Food Program Income
It’s important to dispel any myths or misinformation suggesting that Food Program reimbursements are not taxable. They are indeed considered taxable income by the IRS. Confusion often arises from the older “netting method,” which, while technically valid, is not the recommended or preferred approach.
If you encounter anyone advising you not to report your Food Program reimbursements as taxable income, it’s essential to clarify their understanding and point them towards accurate resources, such as this article or the IRS publications mentioned. Accurate and transparent financial reporting is crucial for the long-term success and compliance of your child care business.
For further information and detailed guidance on record-keeping for your family child care business, consider resources like the Family Child Care Record Keeping Guide. Always consult with a qualified tax professional for personalized advice tailored to your specific circumstances.
