If there's one thing taxpayers fear more than owing the IRS money, it's having their returns audited. While your chances of getting audited are statistically pretty low, it pays to be aware of the moves that could land you on the tax man's watchlist. With that in mind, here are three tax deductions that could result in an audit if you're not careful about how you claim them.
1. Charitable contributions
What's wrong with being charitable? Nothing, if your deduction is legitimate. But if your reported charitable donations for the year constitute a significant percentage of your income, then you'd better be prepared to show the IRS some proof.
The IRS maintains data on average charitable contributions by income level. According to its records, here's what taxpayers claimed in related deductions a few years back based on adjusted gross income (AGI):
|
Adjusted Gross Income |
Average Deduction for Charitable Contributions in 2014 |
|---|---|
|
Under $25,000 |
$1,874 |
|
$25,000-$50,000 |
$2,594 |
|
$50,000-$75,000 |
$2,970 |
|
$75,000-$100,000 |
$3,356 |
|
$100,000-$200,000 |
$4,130 |
|
$200,000-$500,000 |
$7,424 |
|
$500,000-$1 million |
$18,615 |
|
$1 million-$2 million |
$43,944 |
|
$2 million or more |
$382,953 |
DATA SOURCE: IRS.
So, let's assume your AGI is $45,000 and you take a $10,000 deduction for donations. Based on the data above, you'll see that tax filers earning up to $50,000 don't typically claim that much. Furthermore, $10,000 in charitable contributions at that income level equates to donating roughly 22% of one's earnings -- something you don't see even among those making millions.
It's perfectly reasonable to claim a deduction for valid donations to charity. But if your deduction is apt to come off as unusually high based on your income, be sure to have impeccable documentation to back it up.
2. Home office deductions
One of the benefits of being self-employed is that you can deduct home-office-related expenses from your taxable income. But if you're not careful about what you claim, you could wind up getting flagged for an audit.
To qualify for the home office deduction, you must have a dedicated space used solely for business purposes. Setting up shop at the kitchen table with a laptop and notepad does not entitle you to the home office deduction. Rather, you need to have a separate area that serves no purpose other than allowing you to do your job. Furthermore, that space needs to constitute your principal place of business.
IMAGE SOURCE: GETTY IMAGES.
Provided you meet these criteria, you'll then need to be careful about how large of a deduction you claim. To calculate your deduction for indirect household expenses, you'll first need to see how much space your office takes up relative to your home's total square footage. From there, you can write off a proportional amount of your eligible home expenses, including your mortgage payment, homeowner's insurance, heating costs, and water bills.
So let's say you live in a 2,000-square-foot home, and your office takes up 200 square feet of space. If your eligible spending for the year totals $24,000, then you can deduct 10% of that amount, or $2,400.
While you shouldn't shy away from claiming a legitimate home office deduction, don't get cute with the IRS. If you're an author who sits and types all day inside your home office, you won't get away with writing off a portion of your landscaping bill, nor can you write off the cost of maintaining your pool. Furthermore, don't exaggerate the amount of space your office occupies. If you are audited, the IRS will know the difference between a 200-square-foot space and one that's twice that size.
3. Hobby loss deductions
If you earn money from a hobby, you're obligated to report it as income on your taxes. Along these lines, you can also deduct losses from an income-producing hobby -- within reason. In a nutshell, you're only allowed to take a hobby loss deduction if your hobby is actually treated like a business. To figure out if your hobby qualifies, consider the following questions:
- Is your intention in pursuing your hobby to make a profit?
- Have you made a profit from your hobby in the past?
- Do you depend on your hobby to produce income?
- Have you taken active steps to make your hobby more profitable?
If you can't emphatically answer "yes" to any of these questions, then you probably shouldn't be taking a deduction. On the other hand, if your hobby has made a profit in at least three of the past five tax years, you might get away with claiming a loss, provided you have ample documentation backing it up.
While it's true that the bulk of tax audits are conducted by mail, they can sometimes entail a more in-depth process -- and a headache. If you're looking to avoid the hassle and potentially serious repercussions of an IRS audit, be careful when claiming these three deductions in particular.
