There's only one thing taxpayers hate more than paying taxes: a tax audit. While tax forms can be confusing, particularly for those who make a lot of deductions, it makes sense to take a bit of extra time to ensure everything is done correctly. With that in mind, we asked three Motley Fool contributors to highlight some key deductions that could set off alarms at the IRS and result in an audit.
Selena Maranjian: First, most of us should not worry too much about a tax audit. Yes, it can be a hassle, but it's not necessarily trouble. The IRS merely flags certain returns that seem problematic or questionable in some way, and then we have a chance to explain the situation. If you're not trying to pull a fast one on Uncle Sam, you should be just fine.
Still, when it comes to things that might trigger an audit, one danger zone could be home-office or work-related deductions. A home-office deduction might be extra suspect if you also have a salaried job. It can be perfectly legitimate, but the IRS might question it. Traditionally, the home-office deduction has involved calculating what portion of your home is used regularly and exclusively for your business (exclusive use is important -- you can't claim half of your kitchen) -- such as one room out of seven, or 14% of your home. You can then deduct corresponding portions of your rent, mortgage interest, property taxes, insurance, utilities, repairs, and so on. You can also deduct entire costs related to just your home-office space, such as painting, furnishing, or repairing the room in question. If you have a dedicated phone line in the office, it can be entirely deductible. (Of course, painting, repairing, or remodeling some other room in your house is not deductible.)
Calculating the deduction for your home office can be a bit tricky, but the IRS offers a simpler option -- deducting $5 per square foot of your home office, up to a maximum deduction of $1,500. Many self-employed folks working from home also deduct for work-related car expenses and/or work-related meal and entertainment expenses -- know the IRS will consider anything seemingly excessive in those departments as a red flag for possible investigation.
Dan Dzombak: One tax deduction that could lead to an audit is abnormally large charitable contributions. The IRS has years of historical data on how much people generally give. If you donate far more than what is given by people in your income and age bracket, you could be audited by the IRS.
Other red flags with charitable donations include:
- Donating to nonqualified charities. You are only allowed to deduct donations to qualified tax-exempt charities, also known as 501(c)3s. The IRS has a tool that enables you to confirm an organization's tax-exempt status.
- Not filling out form 8283 if noncash donations such as goods, cars, or other items total more than $500.
- Not getting a qualified appraisal of noncash donations such as cars or property if their value is above $5,000.
The important thing to remember is to keep all of your charitable donation receipts. While technically you only need to keep receipts if your total contributions add up to over $250, it's a good habit to get into. For more on this topic, you can read the IRS' complete guide to charitable donations.
Dan Caplinger: The IRS likes to scrutinize areas in which it is largely up to taxpayers to tell the truth about their income and expenses. One potential area for abuse is the vacation home rental business, in which many taxpayers mix personal use of their vacation residences with trying to rent out their properties. Many of the rules covering vacation home rental can be complex, especially because many taxpayers don't understand that their ability to claim deductions is limited to the amount of rent they collect if they also use the property as a home for tax purposes.
Two key aspects of vacation homes can help you avoid audits. First, if you rent the property for less than 15 days, you don't have to report income at all, although you can't take any expenses as deductions. Second, if you use the property and rent it, you have to apportion any expenses across personal and rental use, and those costs that are allocated to your personal use won't be deductible.
Finally, you can't double-dip on deductions, but some expenses that cannot be deducted as rental expenses might be available as itemized deductions on your personal return. As long as you don't try to cheat the system, it's perfectly legitimate to claim deductions for renting out your vacation home.