3 Deductions That Could Expose Your Business to an IRS Audit

By Markets Fool.com

Whereas most employed people who receive a W-2 each year have a very clear paper trail of their income, business owners and the self-employed are essentially trusted to adequately report their revenue and expenses to arrive at their taxable income in any given year. For this reason, business owners are substantially more likely to get audited. Here are three deductions that can raise a red flag.

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1. Home office deduction
Taking a home office deduction that you qualify for is absolutely the right thing to do, but this deduction gets especially tough scrutiny from the IRS. You can claim a deduction for your living expenditures based on the percentage of your home that you use as a home office. Thus, if you have a 300 square foot office in a 3,000 square foot home, you can deduct 10% of your expenses as being business-related.You can also deduct expenses for a separate structure -- a garage, studio, or barn, for instance -- if it is used exclusively for business.

Problems arise when the workspace is not used solely for work or is not your principal place of doing business. The key is exclusivity. If you occasionally do work from your living room, that space doesn't count as being space for a home office.

2. Meals and entertainment deductions
Wining and dining may be an important part of inking a big contract for your business, but whether a particular event or meal qualifies for a deduction is a little tricky. Publication 463 sets the rules for the deductibility of meals and entertainment, setting two "tests" to see if your expenses qualify.

The first test is that a meal and entertainment expense must be in a "clear business setting" and the main purpose is the "active conduct of business." The second test is one of association -- it must be associated with trade or business, and involve "substantial business discussion." Because it's all too easy for self-employed workers and business owners to claim personal lunches as a business expense, these deductions can attract a second glance from the IRS.

3. Mileage deduction
For the 2015 tax year, the IRS allows taxpayers to deduct mileage from their taxes at a rate of 57.5 cents per mile. (The rate drops to $0.54 per mile in 2016.) Those who use five or more cars for business cannot use the standard rate, and must deduct the actual expenses.

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The standard rate allows you to simply multiply the number of miles driven for business by the standard rate to arrive at a deduction. All of the trips you make to meet with clients or vendors, to deliver product, or even trips to the bank qualify as business miles so long as the purpose of the trip is to do business.

The IRS requires that the business owner has proper documentation of miles driven. An IRS publication notes that the records should be "timely kept," and recorded within a week of each travel event. Having a log of mileage can be particularly helpful in the rare event that your tax returns are flagged for an audit.

The article 3 Deductions That Could Expose Your Business to an IRS Audit originally appeared on Fool.com.

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