When reviewing income tax returns we always pay special attention to the Business use of your home section (Line 30) of the Schedule C. The reason we do so is that a lot of our IRS audit representation has stemmed from this troublesome area, the home office expense audit. The IRS knows that business owners often see an opportunity to overstate expenses via their Home Office Deduction. Thus, the IRS auditors, in selecting returns for audit, also pay special attention to the deduction.
If you are keep good records and are doing things correctly, then your chances of being audited are small. The small probability of being audited provides little comfort if you are audited. As for tipping off an IRS auditor, if an auditors sees a deduction that seems inconsistent with the business as a whole, then a red flag goes up.
A good example is a taxpayer with a small income but a large home office deduction. The deduction may well be legitimate. A taxpayer with a large mortgage interest payment will inevitably have a large home office deduction. Nonetheless, the audit red flag is up and the Auditor will come calling.
If I am audited for my home expense, what should I do?
Think like a Boy Scout and be prepared!
- Ensure that you have the correct percentage of use. It is the starting point for the deduction and the accuracy of your claim depends upon it. It will be the first item that the auditor checks. The percentage use is computed by taking the area of the home used for the office and dividing it by the total livable area. A copy of the Assessor’s property card will provide the information you need. If the rooms in your house are approximately the same size, you can divide your office space by the number of rooms in the house to determine the percentage. You should consider both methods and use the best one that you can substantiate.
- Keep a good record of your home expenses. One of the best examples of so doing is to attach a copy of your personal check to the invoice. In addition to being great documentation, it prevents having the Auditor pawing through your personal accounts looking for the claimed expenses.
- Use a business account and business credit cards to keep track of your business expenses.
- Never pay personal expenses from your business account. Doing do only complicates an audit. If you buy building materials to maintain you home, you need to keep proof of payment from your personal account even though part of the expense will become a business deduction.
- Install a separate business line and obtain a separate cell phone. You can deduct the expenses directly on the Schedule C. The separate lines are good indicators that you are conducting a real business and will save a lot of time at an audit. This is especially true where you have bundled services.
- Make sure you not doing something with the biggest audit red flag — improper vehicles expenses.
Don't leave money on the table by not claiming your home office expense
There is another side of the problem that we have not addressed. That is, the businessman who works out of his home but does not take the deduction. By not taking the deduction he misses out on an opportunity to substantially lower his income and payroll taxes.
What can he do? The first task is to set aside a room or portion of the house for exclusive use as an office. The second is to review the steps we have outlined in this blog and the third thing is to consult a tax audit professional who can assist him in setting up the records needed to compute the deduction.