Home Business - Avoiding a Tax Audit - Continued

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Avoiding a Tax Audit | Getting Paid | Budgeting a Home Business Vacationing Away from a Home Business

Six Steps to an Audit-Free Tax Return

1. Be Careful With Deductions

The IRS's favorite target is the home office deduction. In order to qualify for a home office deduction, your office needs to be your "principal place of business" and used "regularly and exclusively" for business. In plain language, this means that your home office needs to be the place where you spend most of your time and make the majority of your income.

You'll also need to keep your personal life out of your home office. For example: a trick that I heard the IRS sometimes uses is to ask the taxpayer being audited "Do you use your computer for 50% personal and 50% business or 5% personal and 95% business?" If you answer 95% business, you have flunked the test -- the answer needs to be 100% business. This example demonstrates the strict enforcement of the guidelines for the home office deduction. We'll talk about this more in Home Office Deductions for Freelancers.

You also need to keep other deductions that you want to take to a reasonable level. Keep a receipt for all deductible expenses, especially food, entertainment, travel, and automobile costs. These are often the deductibles that are most scrutinized by the IRS. You should also keep expenses in a log, along the following information:

The name and location of the expense
Amount paid
Date and time
Company the expense was incurred for
If an entertainment or food expense: the person you entertained or dined
If an entertainment or food expense: the discussion you had

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