Internal Revenue Service United States Department of the Treasury
Level Basic Advanced Military International

Income — Business; Form 1040, Line 12

Clarifying Taxpayers' Business Income and Expenses

Taxpayer Interview and Tax Law Application

A taxpayer, Dana, comes in to have her tax return prepared. She tells our volunteer that she runs her own babysitting business and wants to claim the EIC.

To assist the taxpayer in completing an accurate return, the volunteer needs to ask more questions to determine if Dana did incur allowable business expenses and that the income she reported is correct.

Sample Interview
Volunteer Says…   Dana Says…
Tell me about your business, and were you the sole owner? I have a babysitting service that I handle all by myself.
Do you have a record of your business income and expenses for last year? Well, I'm not very good at keeping records, but I can tell you that I made $14,000 over the course of the year. I didn't have any expenses.
How did you determine that you made a net profit of $14,000? I based my income on deposits to my checking account.
I see. We may be able to reconstruct your business income based on your deposits. Did you bring any bank statements or your checkbook record with you today? No, I'm sorry.
How many children did you care for, and was this a full-time or part-time job for you? Babysitting is just part time. I watch several of my neighbors' children along with my own kids who are 8 and 10 years old.
What is your fee for babysitting? It averages about $10 an hour.
Do you have a calendar or schedule of the children present each day? No, but I may be able to come up with one.
Do you have a business license or permit, and do you watch the children in your own home or in a daycare facility or in the client's home? My home and sometimes at my neighbors' homes. I don't need a permit.
Do you buy any supplies such as food, diapers, toys, or other items necessary for the business? Sometimes I need to buy supplies. But I didn't bring receipts with me.
Did you intend to deduct expenses for the business use of your home? No, I don't think so.
Be aware that the IRS requires that you report all income and allowable expenses on your tax return. In the event of an IRS audit, you will be responsible for providing support for the income and expenses claimed on your return. Before we can proceed, you'll need to gather some additional facts and records. I'll write down a list of items that could help us more accurately calculate your net profit from your business. OK – thanks. I'll see what I can pull together.
[The information provided by the taxpayer appears to be both inconsistent and incomplete, because it is unlikely that someone who operates this type of business:
  1. Has no business expense. Most businesses have expenses, even if it is just a few dollars here and there.
  2. Has annual gross receipts from the business that are an exact round dollar amount, and that amount maximizes EIC.
The volunteer cannot complete a return based on information provided, but gives Dana the chance to gather materials to document her business.]