Exactly what triggers an audit from the IRS isn't always clear. There are plenty of urban legends about exactly which tax deductions can bring you to the attention of the IRS, but not a lot of facts.
In particular, the home office deduction has a reputation for bringing down an audit on a taxpayer. But the reality is a little more complex: Because the home office deduction is often claimed incorrectly, it's seemingly a lightning rod. But with a little care (i.e. good documentation), the IRS won't care about your home office. Rather, there are some other factors that are more likely to trip you up.
Noncash Charitable Donations
Because you have to assign a value to any noncash donations you might make, like dropping off used clothes at Goodwill, this deduction can be a problem area. It's easy to assign too high a value without meaning to. You need to be very pessimistic about the value of any noncash charitable donations you may make, unless you can clearly point to justification for your valuation.
Real Estate Losses
If you take a loss on a real estate investment, you need to be able to show that it's not a passive investment. That means that you have to be active on a regular basis, in a substantial way. This isn't an issue for real estate professionals, but if you're just collecting rent for a property and wind up with a loss, you may have some problems.
Travel and Entertainment Deductions
As a business owner, you may be able to write off a portion of your travel, entertainment and food expenses as deductions. But your deductions need to be in line with what's reasonable for your business. Even if you're earning a lot of money, each deduction needs to clearly meet the business purpose test if you don't want to talk to the IRS about it.
If you're taking deductions for a business that routinely carries a loss, the IRS is going to take a close look at what you're doing, and they may reclassify your business as a hobby. For a business, you need to be able to show that you depend on the income from the activity and that you're seriously looking for ways to turn a profit.
S Corporation Wages
For companies operating as S corporations, particularly smaller ones, there's a question of what constitutes a fair wage. The IRS will take a close look at the salaries of employees of the corporation to make sure that the wages meet market rates. If they don't, the agency may conclude that the corporate structure is simply an effort to avoid paying taxes.
Unreimbursed Employee Business Expenses
Because you can only deduct unreimbursed expenses incurred as an employee when the total goes over 2% of your adjusted gross income, there's a tendency to abuse this deduction by writing off work clothes, the cost of getting to work and other expenses that aren't allowed. You'll need to properly document any expense you're claiming as an employee and double-check that it is allowed.
The Bottom Line
If you're worried about your tax return, make the time to go over it with a tax professional before you turn it in to the IRS. You may be able to find potential problems and resolve them ahead of time. Avoiding math errors and accurately reporting the numbers on your other documents will reduce your chances of being audited dramatically. The IRS only audits about 2% of all tax returns it receives, so if you can avoid red flags on your tax return, you may be able to avoid an audit.
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