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Dangerous Deductions:
How to Steer Clear of the IRS

By Diane Seo   Fox Market Wire

So, you're considering writing off your cruise to Mexico as a business travel expense, even though your only work-related activity was checking your voice mail from the ship's spa?

 

You might want to think again, unless you relish the paperwork nightmare of IRS auditors combing through your receipts to verify your so-called business expenses.

Although only about 1 percent of individual income-tax returns are audited, your tax return could be among those that signal the IRS if you take too many liberties with your deductions. Those in higher income brackets (incomes of $100,000 or more) should be even more cautious, since the IRS tends to be particularly suspicious of the rich, as well as those with their own businesses and those filing estate-tax returns.

"There's no way to tell who's going to get audited, but the IRS does tend to clamp down on higher-income returns," said Ross Levin, a certified financial planner at Accredited Investors in Edina, Minn.

For instance, 2.77 percent of individual tax filers, with incomes of $100,000 or more, were audited in 1997. That figure was about four times higher than the percentage of audited taxpayers in lower income brackets, according to IRS figures. Meanwhile, between 2.57 percent and 4.13 percent of those who filed a Schedule C (Sole Proprietorship) were audited that same year, depending on their income bracket.

Nevertheless, taxpayers of all income brackets shouldn't be deterred from writing off expenses, as long as they can prove through receipts or other written documents that they're legitimate.

"The only way to do things is to be honest and straightforward," said Daniel Gerard Corrigan, a certified financial planner in Newport, R.I.

Corrigan said the main thing to remember when considering expenses is to ask yourself, "Is this related to how I make money?"

"If these expenses are related to the production of income, then you can take them," he said. "But there are many gray areas. A lot of people get into trouble when they try to turn personal expenditures into tax deductions."

For instance, Corrigan warned about writing off a home computer unless it's specifically used for work. And just because you need a car to commute to and from your job, don't get tempted to deduct that new BMW in your garage.

Taxpayers also should be careful about educational expenses. A computer class that enhances your job skills is a valid deduction, assuming your company has not already reimbursed you. But, don't write off a Web design class if you're an accountant, even if you're planning a career switch. The classes must directly relate to an income-producing job you now have.

Miscellaneous Items
That Cannot Be Deducted:

  • Work clothes, even though your company expects you
    to wear a suit

  • Home cable TV costs, unless you must watch the tube to
    do your job

  • Political contributions

  • Traffic tickets, even if you were using a company car

  • Personal legal expenses

Excessive entertainment and travel expenses also tend to attract IRS scrutiny, the planners said. "People look to write off vacations, when they spent just an hour or two on business," Corrigan said.

The planners said when calculating such expenses, taxpayers must consider the true purpose of their trips or dinners out. If they spent half their time away tied up in business meetings, they probably can take the deduction. But if they take a friend out to dinner and chat about their bosses, they're asking for trouble if they try to throw that bill into their pile of entertainment expenses.

Writing off home office expenses used to be a questionable practice, but the rules have loosened considerably this year. Before, home office expenses only could be deducted if the taxpayer's home served as the primary place for business or was regularly used for business meetings.

Now, taxpayers can claim a deduction if home offices are used regularly for business. Those meeting this less-stringent criteria can write off a portion of utilities, mortgage interest, rent, repairs and other costs, depending on the ratio of office space to living space.

Although many taxpayers now make their own calls about deductions, those with long lists of questionable items probably should consult a professional before submitting their returns, the planners said.

"Don't try to make decisions about deductions unless you're sure," Corrigan said. "And always make sure to keep receipts and write down everything."


 
   
 

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