If you’re self-employed and file a Schedule C you should be aware of tax deductions that may cause an IRS tax audit.
The IRS spends a great deal of time scrutinizing the home office deduction, automobile expenses, and travel and entertainment expenses. If your deductions for these expenses are not in line with IRS statistics and ratios you are a likely candidate for a tax audit. However, if you have incurred these expenses and they are valid business deductions you should not be afraid to claim them on your tax return.
Home Office Deduction
An adjustment reducing or eliminating this deduction is frequently made as taxpayers do not meet the requirements to take the deduction or do not correctly calculate the amount of the deduction. In order to qualify for the home office deduction the taxpayer must use a portion of their home exclusively and regularly in their business. Generally, exclusive use means a taxpayer uses a specific part of the home solely for business and no other purpose. There have been many court cases which provide guidance relating to this issue.
When computing the home office deduction you will need to know the size of your home or apartment and determine the size of the space used exclusively for business purposes. For instance, if the size of your dwelling is 1800 square feet and you dedicate a room with 100 square feet for your business you would deduct 5.55% of allowable expenses. We recently received a call from a taxpayer who was notified that his 2011 tax return was to be audited. One of the issues was the home office deduction. The taxpayer had calculated the percentage of his home used for business purposes to be 66.67%. He reported the size of his home to be 2400 square feet and claimed to regularly and exclusively use 1600 square feet for his business. Talk about waving a red flag and asking to be audited. After questioning the taxpayer I determined the size of his residence was less than 800 square feet and he used less than 90 square feet for his business, resulting in approximately 11% of business use.
Taxpayers are allowed to deduct expenses incurred for the operation and maintenance of an automobile used in a trade or business. However, expenses attributable to personal use of the automobile are not deductible. Allowable expenses include such items as lease payments, depreciation, insurance, fuel, maintenance and repairs. A taxpayer may choose to deduct actual expenses incurred or use the standard mileage rate allowance, but not both. We have seen taxpayers take both actual expenses and the standard mileage rate as a deduction, thus triggering a tax audit.
Most taxpayers can document the expenses incurred in operating and maintaining their automobile but many do not maintain adequate records to prove the percentage of business use. Logs, diaries or trip sheets are acceptable evidence of the business use of an automobile. If you find you do not have the required documentation, the tax professionals at East Coast Tax Consulting Group can instruct you on how best to recreate a log detailing the business use of your automobile.
Travel and Entertainment Expenses (T&E)
These expenses are fertile ground for disallowance by the IRS. T&E includes items such as airfare, lodging and meals while out of town, business meals with clients, and business gifts. An audit is often triggered when a taxpayer deducts an unusually high amount of T&E in relation to his/her business income. During the audit process, the IRS may find that a taxpayer has attempted to deduct a vacation or travel expenses for family members not involved in the business. Such expenses will result in an adjustment causing an IRS tax debt. The law requires a taxpayer to substantiate T&E with adequate records that provide the amount of the expense, the date and place of travel or entertainment and the business purpose. As with the documentation of auto expenses we can assist you in providing the IRS with the required substantiation for your T&E.
How East Coast Tax Consulting Group Helps Self-Employed Taxpayers
We begin helping taxpayers long before notification of an IRS audit. We provide tax consulting and planning advice which includes informing our clients as to IRS recordkeeping requirements. You do not want to lose valid tax deductions due to lack of documentation. Although we cannot guarantee that your tax return will not be audited, we can help reduce the possibility of an audit with proper tax planning, and our expert tax preparation services.
If you are unfortunate enough to be subject to a tax audit we will provide you with expert representation and negotiation services. Our experience and extensive knowledge of the tax laws has allowed us to successfully represent taxpayers in IRS and State tax audits for many years. Call us at 866-550-7655 for a free consultation.