Though most tax audits aren't the harrowing experience we've all come to fear, they're not necessarily a picnic either -- especially if your return boasts its share of questionable deductions. But before we go any further, let's get one thing straight: Taking a series of verifiable, genuine deductions shouldn't land you in hot water with the IRS. Abusing those deductions, however, could get you into trouble. With that in mind, here are three deductions you need to be careful about.
1. The home office deduction
If you're self-employed and conduct business out of your home, you're allowed to take a home office deduction provided you meet two key criteria -- that your home office space is used exclusively for business, and that it constitutes your primary place of business.
Here's where some people get into trouble. Say you're a freelance consultant who sometimes does billing from home but mostly meets with clients in a rented office space. Since the majority of your work is done outside your home, you can't claim the deduction. Furthermore, if you live in a 600-square-foot apartment with just an eat-in kitchen and bedroom, you're going to have a hard time getting away with claiming a home office. Even if you do perform most of your work from your kitchen table, you won't fulfill the aforementioned dedicated-space requirement.
Now, you're free to take a home office deduction if you meet the above conditions, but be careful with what you claim. Typically, you'd claim a home office deduction by figuring out how much space your office takes up relative to the rest of your home, and then writing off a proportionate percentage of your home-related expenses. So if, for example, you have a 2,000-square-foot home, a 200-square foot office, and $20,000 in home expenses, you'd get a $2,000, or 10%, deduction. What some self-employed folks tend to do, however, is exaggerate the amount of office space they have to maximize their deductions. And that's a dangerous move, because if you're claiming 400 square feet of office space in a 1,600-square-foot home, there's a good chance the IRS might want to investigate.
2. Business expense deductions
Another benefit of being self-employed is getting to deduct business expenses, including travel, equipment, and mileage on your vehicle. But getting too liberal with your deductions could land you right on the IRS audit list.
First, be careful when writing off travel costs. It's perfectly acceptable to deduct a trip whose primary purpose is business-related, but if you spend three days in a destination city and squeeze in one or two brief business meetings, that's hardly a legitimate write-off. Similarly, if you work as a copy editor from home but claim thousands of miles on your vehicle each year, it might arouse suspicion.
Finally, be careful when writing off purchases that aren't critical to your business. If you're a writer, by all means, deduct the cost of a new laptop, but don't think you can get away with claiming the cost of your new flat-screen TV. Even if you do occasionally watch the news for research, it probably isn't going to fly.
3. Charitable donations
You're allowed to take a deduction not only for cash donations, but for whatever unwanted goods you give away to a registered charity. And it's the latter category that tends to get taxpayers into trouble. If you donate money to charity in the form of a check or credit card payment, there's typically a solid record supporting your claim. Donations in the form of goods, however, are harder to prove.
Even if you retain a record of the specific items you give away, you'll need to make sure your deduction doesn't exceed the fair market value of the things you donate. In other words, if you donate a used coat you once bought for $200, you can't take a $200 deduction, because that's not what the item would sell for in its present condition. Be careful about how much you deduct for donated goods, and when in doubt, consult an established guide to see how much to claim per item. Furthermore, make sure your total charitable deduction isn't inordinately high given your income. It's one thing to make $50,000 a year and take a $1,500 deduction, but if you're claiming a $10,000 deduction, equal to 20% of your income, that's bound to raise a red flag.
As a general rule, the more documentation you have to support your deductions, the less trouble you're likely to run into. Even if your tax return is audited, if you make it a rule to only claim deductions that are 100% legitimate, you're likely to come away unharmed.