Unlicensed child care providers are part of a broad category of businesses that the IRS considers part of the underground economy. Like carpenters who build decks on weekends, house cleaners or waste haulers who work for cash only, these businesses often charge less. They are able to do so because skipping their tax and licensing obligations lowers their overhead and gives them a competitive advantage over providers who comply with the law.
The IRS says that all income from child care is taxable income, this includes income from serving as a neighborhood babysitter, in-home childcare provider or a family-run day care in a home. In general, the IRS's audit guide for child care providers will look for income that is understated and expenses that are overstated. Because record keeping is often poor or non-existent, the IRS uses a variety of techniques to reconstruct income and expenses.
Failure to File or Late Filing
The penalties involved in skimping on taxes depends on the method used to evade them and the amount of tax liability you owe. A failure to file a tax return may result in a 5 percent penalty for each month, up to 25 percent. The penalty for late payment of taxes owed is equal to 1/2 of 1 percent of the amount owed for each month of non-payment.
The big risk for an informal child care provider is the risk of understatement of tax liability. If you understate taxes by either $5,000 or 10 percent of tax liability (whichever is greater), you could be liable for a 20 percent tax penalty. You may be able to avoid this penalty if you report the understatement yourself, and have a very good reason why you understated the income in the past.
Understating income from an erroneous interpretation of tax rules can be substantial. It is not as substantial as a finding that you have intentionally and fraudulently under-reported income. The civil fraud penalty may result in a 75 percent penalty added to your tax bill. Criminal penalties may also apply.
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