Top Tax Write-Offs That Could Get You in Trouble With the IRS Before you try to take that questionable deduction on your taxes this year, find out exactly what could raise a red flag with the IRS.
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From guard dogs to Las Vegas-style showgirl costumes, there's no limit to what people will try to write off at tax time for the sake of their business. But where do you draw the line? Which write-offs you're trying to write off go too far?
We assembled a team of three leading tax attorneys to get their advice on how far is too far in the land of tax write-offs. Our team of experts include Cliff Ennico, a Connecticut-based business attorney who specializes in advising small businesses and entrepreneurs; Donna LeValley, a tax attorney and contributing editor to the J.K. Lasser annual tax guide; and Alvin S. Brown, a tax attorney who formerly worked with the office of the chief counsel of the IRS for more than 25 years.
Tax Write-Off: Travel Expenses
Here's a write-off that's sometimes difficult deciding just where to draw the line. Can you deduct the cost of going to see a Cirque du Soleil show in Las Vegas if you're treating your client? The answer is yes, as long as you can justify it as a business expense. And what if your spouse goes along on the trip? As long as they're a partner or employee of your business and attended conventions or meetings on the trip you took together, then his or her travel and 50 percent of his or her meals are also deductible.
- Expert Opinion: "You can deduct travel expenses, and 50 percent of related meals and entertainment, if the travel is reasonably related to your business," explains Cliff Ennico.
- How to Do It Right: Here's a tip from Donna LeValley that will come in handy on your next business trip: Grab an envelope from the stationary drawer of your hotel room and put all your receipts from that trip in it. Label the envelope with a name and date to help you remember that trip. The more accurate your records are, the more likely they'll be accepted and validated by the IRS if you become involved in an audit situation.
Tax Write-Off: Cell Phone Bill
If you use a cell phone as part of your business, this could be a big deduction for you. So don't make the mistake of mixing business with pleasure by sneaking too many personal calls onto your cell phone bill.
- Expert Opinion: "Because of the way a cell phone can be used, it's come under scrutiny, so people need to keep good records and keep their actual telephone bill so they can demonstrate that a majority of the calls were business calls," explains LeValley.
- How to Do It Right: Take a look at your cell phone bill to make sure you receive an itemized report. Because cell phones are considered listed property, you need to keep detailed records of their use. In the case of a land line, it's a good idea to have a separate phone number for your business since the IRS won't let you allocate the cost of a single phone in your home to your home office.
Tax Write-Off: Home Office
Home office deductions used to be a big red flag for an audit back in the 1990s. These days, you just need to use the deduction with caution. A basic rule of thumb to follow? "Anything that's unusual and disproportionate to your level of income is something the IRS will check out," Alvin Brown says.
So how do you determine your actual home office space? This is the area in your home dedicated solely to the running of your business. Once you figure out the percentage of your home office compared to your overall home, then you can go back to your heating bills, electric bills and all other bills that go to supporting your home, and figure out the amount you can deduct for running your business.
- Expert Opinion: "Don't measure your home office space yourself. When you do, you almost always shortchange yourself," says Ennico.
- How to Do It Right: It's a good idea to have a contractor measure your space professionally. They can provide you with a letter stating the exact square footage of your home office space should you need to substantiate it with the IRS.
Tax Write-Off: Home Office Computer
As our experts pointed out before, it's not a good idea to mix your business world with your personal life. So they recommend never using your home office computer for personal tasks if you can help it.
- Expert Opinion: "If this is the only computer in your house, you'll have to calculate the percentage of total time you use it for business purposes," suggests Ennico.
- How to Do It Right: Ideally, your best option is to purchase a laptop and dedicate it to being your personal computer. This way you can avoid any messy situations come audit time.
Tax Write-Off: Rent
Wondering if you can still take the home office deduction if you're a renter? The answer is yes. But you need to know the right way to go about it.
- Expert Opinion: "If your landlord is an individual or unincorporated business, such as a partnership or LLC," says Ennico, "you may have to send IRS Form 1099 to your landlord in January of each year showing how much of your rent you're deducting."
- How to Do It Right: To ensure that you handle this deduction appropriately, it's a good idea to check with your accountant for details.
Tax Write-Off: Personal Expenses
This is a category business owners can easily get into trouble with if they're not careful. The bottom line is, you simply can't deduct services of a purely personal nature that aren't related to your business. For instance, you can't deduct such homecare services as gardening, landscaping and tree removal simply because you work out of a home office.
- Expert Opinion: "People start to get in trouble when they try to make personal expenses business expenses," says LeValley.
- How to Do It Right: If in doubt as to whether an expense is deductible for your business, LeValley recommends getting a second opinion. "I think that even if you're very capable and even if you've had some experience on your own," LeValley says, "it's always good to get what I call a 'financial checkup' every once in a while."
Tax Write-Off: Guard Dog
In order for a dog to qualify as your company's guard dog, it helps, says Ennico, if you're a little afraid of the animal yourself (picture a Rottweiler, Pit Bull or German Shepherd). Believe it or not, this is a legit write-off if taken correctly.
- Expert Opinion: Ennico points out how to use it: "You'll only be able to deduct that portion of his or her total time devoted to 'guard-dog' duty."
- How to Do It Right: Though it may seem rather obvious, your dog most also be guarding your inventory. Another interesting tidbit: Though you can deduct expenses relating to the dog, you can't deduct the dog itself. But you can depreciate it over its expected lifespan as determined by a local breeder. Who would've thought?
Tax Write-Off: Work-Related Uniforms or Costumes
The dos and don'ts of this tax write-off are fairly simple: If the costume or uniform is something you could wear outside your job, you shouldn't write it off. If, however, it's obvious you can only wear it for the duties of your specific job, then it qualifies as a write-off. So a new suit wouldn't qualify since you can wear it other places outside of your work environment. What about a clown suit, you say? That's a different matter.
- Expert Opinion: LeValley urges taxpayers to go for the write-off if it's a legit expense. "If the expense is real, take it," she says. "It may be strange, it may be large, but whatever it is, if it's real, be prepared to substantiate it but don't be afraid to do it."
- How to Do It Right: A perfect example of some rather unusual clothing you can write-off involves a Las Vegas showgirl who was trying to write off the tight, sequined costumes she purchased for her performances. LeValley says the showgirl was told she couldn't deduct the costumes since they were clothing and she could wear them elsewhere. To prove that theory wrong, the woman showed up at her audit in one of her costumes and said, "Where in the world do you think I could wear this? I can't even sit down!" Needless to say, she won her case.
Audit Triggers: The Biggest Red Flags to Watch Out For
Here are just a few more things you want to be careful with when it comes to taking deductions on your business taxes:
All in the family. When employing a spouse, child or close relative, be careful not to give them any extra-special treatment. Make sure the responsibilities of their job description are commensurate with their age and experience. Pay them the same salary you'd pay anyone else doing the same job.
In the money. An excessively high income compared to previous years can stand out and trigger an audit. And high-income taxpayers are more likely to be audited since they're more likely to be involved in complex transactions and have partnerships, trusts or businesses.
Consistency is key. The IRS will notice if your federal return is disproportionate to your state return, so be careful to ensure they're consistent.
Stay on the up and up. People who've filed frivolous lawsuits in the past are most likely always going to be audited. Considering not filing your taxes at all? Here's something that may cause you to re-think your decision: People who haven't filed their federal taxes can be picked up for fraud, hit with a felony and do jail time. Even if you don't have the funds to pay off everything you owe, Brown strongly suggests filing anyway--it's better to file and not pay all you owe than wait until you have all the funds and risk getting hit with penalties or worse.
Know your preparer. More and more, the IRS is using a software program to check up on tax-return preparers. If they notice a high error rate, they'll not only audit the return-preparer, but they'll also audit that person's clients as well. So do your homework before choosing a preparer. And if you ever have any doubt as to whether they're guiding you in the right direction, seek an outside opinion before proceeding.
Protect yourself. If you are selected for an audit, Brown recommends standing up to the IRS by getting representation. As a former IRS insider, Brown says that these days, the IRS is "a bit out of control--they aren't enforcing the tax law with professionalism."