The IRS’s latest target is abusive tax schemes involving false and inflated home business deductions for operating home-based businesses. Taxpayers are more aggressive today than ever before about deductions and may be easily persuaded that a home-based business is their ticket to more deductions. These scams are currently being promoted, especially on the Internet, with promoters actively encouraging taxpayers to play the audit lottery. Promotions boast inflated deductions, home-based “businesses” that are nothing more than shams, and bogus deductions for personal expenses disguised as business costs.
Generally to be deductible, the business part of the taxpayer’s home must:
- be used exclusively and regularly for taxpayer’s trade or business; and
- be taxpayer’s “principal place” of business.
Expenses may still be deductible if taxpayer’s residence is used to meet customers, or if a separate structure on the taxpayer s residence property is put to business use. Direct business expenses (those only for the business part of the taxpayer’s home) generally are fully deductible, while indirect expenses (e.g., utility, repair and security costs) may be partially deductible. Unrelated expenses are not deductible, and it is this abuse that raises red flags for the IRS. The IRS is on the lookout for deductions of:
- all or most of a personal residence cost by placing business equipment in every room;
- Mortgage or rent for a business that exists only on paper;
- Salaries paid to children for business services, e.g., answering the telephone;
- Education expenses from the salaries paid to children;
- Excessive automobile and transportation costs;
- Costs of furniture, home entertainment, and food; and
- Personal travel expenses disguised as business trips.
The IRS has also recently warned taxpayers of a fraudulent investment scheme involving the Disabled Access Credit. The scam involves promoters selling expensive coin-operated pay phones with volume controls to individual investors instead of businesses, and leasing back and servicing the phones, usually for a fee, with taxpayers claiming up to a $5,000 credit on their individual returns. The credit is disallowed by the IRS for taxpayers not operating as a business or not qualified as an eligible small business, and if the purchase is not an expense that makes a business accessible to disabled individuals.