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Everyone loves to discover a valuable and legal tax benefit that makes them eligible for deductions. There are all sorts of categories of business expenses, for instance, that a small business owner or sole proprietor such as a freelancer can list as legitimate deductions.
Let’s say, for instance, that you run a day care center in your home and can calculate the amount of square footage in your house that is devoted to that enterprise. You can then use that data to extrapolate the portion or percentage of your home that falls under the business umbrella for tax purposes. You also have to pay for utilities to keep your day care business going. If you give rides to children in your automobile to go on educational excursions or to pick them up or drop them off at home, you should also be able to deduct a percentage of gas and vehicle maintenance as a day care business expense.
The same goes for an almost unlimited list of at-home businesses, professions that require a home office, or employment that requires you to use your own vehicle for transportation related to your job. Perhaps you are in sales and you travel extensively, which means lots of hotel and airfare expenses, too. You may need to entertain clients, pay for business luncheons, or take prospective buyers out to dinner. A resourceful accountant can help you tally up plenty of expenses such as those and then subtract them from the grand total that you wind up owing Uncle Sam.
You May Not Want to Take Every Deduction Allowed
Many tax experts advise against taking every possible deduction, however, even though they acknowledge that they may be perfectly legit and within your rights as a taxpayer. That’s because some categories of expenses tend to raise red flags at the IRS, which could put you at higher risk for closer examination. Here are a few scenarios of those abusing their tax deduction privileges:
- The taxpayer operating a day care facility out of her own home, for instance, may be taking business deductions for rooms in her home that are used for day care during the day, but for personal and family purposes at night and on weekends.
- The real estate agent who deducted the cost of a copier machine justified doing so because the equipment is used for printing purchase contracts for buyers and photos of listings for sellers. If he uses the same copier to print out photos from his vacation or to make copies of emails from his children who are off at college, though, that is not a business-related activity.
- Perhaps an event planner is accustomed to paying for fancy meals while she cultivates new clients and then deducts those as tax write-offs. When she starts to also deduct the cost of her scones at the coffee shop or brunches with friends, that crosses the line and violates the rules.
- Anything dealing with travel. You may have a business convention to attend in Orlando, but when you bring the family along so they can visit Disney World you are mixing business with pleasure, and that is exactly the kind of behavior that raises suspicions at the IRS.
Think Twice Before Overusing These Deductions
In addition to the deduction scenarios outlined above, it is wise to proceed with caution and pay close attention to details if you plan to take any of the deductions listed below. They tend to stick out like a sore thumb at the IRS. If you are not 100% entitled to the deduction it may come back to haunt you in the form of an audit, penalties, and fines.
- Extremely large charitable donations relative to the amount of your annual income, particularly non-cash donations, can make the IRS skeptical. When donating property of value you need to support its value with a professional appraisal. Similarly, if you do not file an IRS Form 8283 for non-cash donations over $500, that can trigger additional IRS scrutiny.
- Taking business deductions for something that is actually just a hobby can be a big mistake. The IRS is hip to that scheme. One story reported in the news, for example, explained how a millionaire tried to deduct the use of his private pleasure yacht as a business expense related to some kind of maritime services he was not actual providing.
- Alimony deductions – which do not include child support, by the way – are apt to raise eyebrows at the IRS, especially when the information reported on the two ex-spouses separate tax forms don’t match. This raises flags because some people who pay alimony inflate those payments in order to take a larger deduction.
- Failure to report a foreign bank account is a no-no if the total amount held outside the USA adds up to at least $10,000 at any time during the tax year. You need to file an IRS form FinCEN Form 114 to report that money.
To learn more to help you understand your responsibilities or liabilities, visit the IRS website. This article provides tables of deduction categories and the amount that would likely catch a tax auditor’s attention.
Don’t Be Afraid to Take Deductions You Earned
Do keep in mind, however, that many taxpayers are completely eligible for these kinds of deductions, and if that includes you, then you have every right to claim them. Just make sure you can back up your claims with supporting documentation, and be aware that taking claims that look unusual or exceptionally high can make you a target of closer IRS inquiry.
IRS oversight is intended to be for your own benefit. Ultimately it protects your rights as a legal taxpayer by discouraging those who would take illegal advantage of the kinds of deductions you deserve. As always, consult a tax preparation expert or qualified financial planner for individual advice and guidance regarding these kinds of important tax issues and questions.