Getting audited is many taxpayers' worst nightmare, but that shouldn't stop you from taking advantage of the tax deductions you're legally entitled to take. You should just take care to make sure you have the documentation you need to back up your deduction if the IRS decides to take a closer look at your return.
Below, you'll learn about three tax deductions that often raise red flags from would-be auditors.
1. Home office deduction
Self-employed entrepreneurs often work out of their homes, and the tax laws provide for such businesses to deduct the legitimate expenses that are connected with their home-based business. If you meet the requirements for a portion of your home that's used regularly and exclusively for business use, and is your principal place of business, you can usually prorate your overall household expenses by the fraction of your home's total area that your business takes up. In addition, you can deduct in full expenses that are directly linked to your business and aren't shared throughout the remainder of your home for personal use.
Abuse of this provision has led to increased IRS scrutiny. The most important thing to remember is that you need to be able to document the separate area and its exclusive business use, so if your business takes up a large fraction of your overall property, you'll need to prepare to prove it. In addition, ensuring that all claimed expenses are business-related is important in maintaining your credibility during an audit.
2. Charitable deductions
Donations to charity are usually tax-deductible to those who itemize their deductions, and the IRS has paid increasing amounts of attention to charitable deductions in recent years. Gifts by check are hard to falsify, but claiming large amounts for donated items like cars or used clothing has been a frequent area of abuse among taxpayers.
In judging your charitable donations, the IRS will compare your deductions with those of taxpayers in a similar financial situation based on your tax return. If you're on the high side of average, the risk of an audit will increase, and it'll be more important for you to keep good records on what you gave, when you gave it, and how you determined the appropriate value of the property. Fail at any of those tasks, and you could be left unable to support your deduction to an IRS auditor.
3. Unreimbursed business expenses
Most of the time, employees get reimbursed by their employers for any business expenses they pay for themselves. As a result, the IRS looks carefully at unreimbursed business expenses, even though they're an itemized deduction and are only deductible to the extent that they exceed 2% of adjusted gross income.
Many items are potentially deductible, including dues and license fees, subscriptions to trade journals and publications related to your work, tools and supplies, and specialty uniforms. Yet the temptation among many taxpayers is to try to deduct additional items that are only somewhat connected to their jobs. Before taking this deduction, make sure the expenses you're seeking to claim are legitimately business-related, and be prepared to explain in an audit why your employer didn't reimburse you for them.
Finally, bear in mind that any deduction could lead to an audit if it's unusually large compared to what most people report on their tax returns. If you're entitled to a big deduction for any reason, make sure you have the records to prove it in case the IRS comes knocking.
Getting audited is no fun, but as long as you have the required documentation, you should be able to stand up to IRS scrutiny with your deductions intact. Keeping good tax records with these three deductions in particular is a smart move that will keep you from paying extra tax after an audit.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.