June 18, 2013

Do Home Office Deductions Lead to IRS Audits?

I've seen a lot of people claim that taking a deduction for a home office on your taxes is a red flag for the IRS and leads to a higher audit risk.    I've been cynical of that for some reason.    I'm not too sure why I'm cynical about the claim, but I am.    It seems to make sense that the IRS might target deductions that are commonly ... how shall we say it? ... "exaggerated"?   or "embellished"?   But then its hard to see any cause - effect relationship between any given deduction and an audit.   The IRS does not publish any kind of statistics on what percentage of people audited claim specific deductions.   There is no real solid data to support or refute the idea.   It may be impossible then to prove or disprove the idea that any given deduction causes higher audit rates.

I went out to Google and searched for 'home office audit risk' and found several articles discussing the topic.  However there was no consensus with some articles saying theres no evidence of any audit risk and others claiming it as a fact.  

Opinion #1 :   No Evidence

In : Skip home-office deduction to avoid audit?
Mark S. Gleason who is an Adjunct Professor of Accounting at the University of St. Thomas Opus College of Business.

says: "Having worked with many taxpayers who have claimed home-office-expense deductions, I have seen no evidence that taking a home-office deduction creates additional audit risk. I could not prove this statistically."

Opinion #2 : Assumes an audit risk

in First Person: Assessing My Income Tax Audit Risk a 'Yahoo Contributor'
says: "Most tax professionals encourage work from home taxpayers to deduct this expense, as long as it is under, say 10%. IRS does as well, as long as the requirements are met. However, unless I can provide definitive proof, the income tax audit risk appears to outweigh my income tax savings."

But I have no idea where they get that 10% figure from and I"m not sure exactly what its 10% of.

Opinion #3 - States IRS audits people

in Tax tips: How to avoid an IRS audit
 written by Jeff Reeves who's bio on Amazon says he's a journalist

"These deductions were abused for years by people who did a little work in the den in exchange for a lot of tax benefits they might not have deserved. The IRS frequently audits those claiming home office deductions, making them prove "exclusive use" for business purposes."

Opinion #4 - Says there is 'no evidence'

Theres two references from  Barbara Weltman who is a 'tax and business attorney since 1977' and author of multiple tax books :

in Three Myths About the Home Office Deduction
"There is no evidence that this deduction exposes a taxpayer to greater audit risk.
If you are entitled to a home office deduction because you meet all tax law requirements (e.g., you are a home-based freelancer who uses a space bedroom solely as an office), then take it."

and in How to Claim a Home Office Deduction and Sleep at Night
"It's generally assumed that if you work from home and claim a home office deduction, you're sending a red flag to the IRS and inviting an audit. While the IRS doesn't give statistics on audit triggers, it's important to know how to protect yourself if you claim a home office deduction"

Opinion #5 - Says its a 'red flag'

How Your Home Business Can Avoid a Tax Audit
by Karen E Klein who is a columnist / journalist 
says: "The home office deduction acts as something of a red flag to the Internal Revenue Service because it can easily be abused by small business owners who claim a larger home office than they actually have, or who deduct expenses for an office that is not truly dedicated to business use. "

Varying opinions 

There are five different opinions cited above from five different sources.    We've got two opinions #1 and #4 who say there is 'no evidence' of any audit risk.    Then we've got two opinions (#5 and #3) that say there is risk.   One opinion #3 goes as far as stating outright that the IRS "frequently" audits people who claim the home office.   Opinion #2 refers to the risk and just assumes it as if its somehow common knowledge.

I Trust the Experts

If we split up the opinions by experts in the field of taxes versus people who are journalists then we see that the two experts say there is 'no evidence' and the two journalists claim it is a risk.   However theres no evidence presented by the journalists nor do they cite a source or provide any data at all to back that claim.   Given that we've got conflicting claims here I'm inclined to trust the opinion of the tax experts.   The experts say there is no evidence of higher audit risks.

My Theory

This bit is just my own personal opinion and guesswork.    I'm thinking what happened is that some people took home office deductions and then got audited.   This lead to someone making statements claiming that the home office deduction causes IRS audits.   It may have either been isolated anecdotal reports that got picked up and repeated by the media.   It may have also been a more wide spread correlation between high audit rates and high home office deduction claims.   But as we know correlation does not imply causation.   Maybe there were a LOT of people who claimed home office deductions and who got audited... and maybe that was because they were improperly claiming the home office deduction.   One might assume that the real story is that "improperly claiming home office deductions leads to audits"  which isn't any kind of revelation.   If you improperly claim any kind of deduction then that will result in higher audit rates.   The IRS does obviously look for people who improperly claim deductions and will audit those more often.    I honestly do think that there are probably a lot of people who improperly claim the home office deduction.  Its actually not an easy deduction to take and the rules are strict.  

Bottom Line : There isn't a clear consensus on whether or not home office deductions lead to increased risk of IRS audits, however the tax experts say there is no evidence to support that idea.  



  1. Great post! This is something that I've been thinking about a lot, as I will be making the switch soon.

  2. How would the IRS know that you are improperly claiming a deduction? They don't have a crystal ball, surveillance cameras outside your house, or anything like that. All they do have is data about your income and deductions. To me that supports the otherwise out-of-the-blue "10%" rule favored by the "Yahoo Contributor."

    Said Contributor made another odd comment, though. The "risk" of an audit outweighs the benefit. What is the cost of an audit? There is a risk that some deductions, either the home office or even unrelated deductions, that will get denied or reversed. But if you are properly claiming all your deductions, then the only cost is your own time and/or paying for representation in the audit process. Not claiming a legit deduction to avoid an audit risk seems like cutting off your nose to spite your face.

  3. @SteveD, I have been subject to several inquiries/audits from the IRS and completely understand the risk/benefit point made. The IRS representative is getting paid by the hour, and treats me as if I am getting paid by the hour. Answering form letters, sending documentation by 'fax' (who uses faxes today? The IRS, because they don't want an e-mail 'conversation' and won't give you their direct phone #), and the worst is meeting them at their convenience at their location.

    Ideally, we should all take the deductions to which we are entitled. But the downside to taking a $1,000 deduction to which I was entitled ($350 reduction in my taxes) resulted in something that took two years to resolve, and took twice the effort because I had to deal with my CA state Franchise Tax Board who received the information from the IRS and duplicated the audit. Days off work (costing me a days pay) for a 20 minute meeting, many letters and replies, waiting months for acknowledgement of my reply and receiving only another inquiry instead, and sleepless nights while this silly item was unresolved. I paid $500 when I received a bill from the IRS (no explanation how they arrived at that figure) just to end it.

    When you say "...the only cost is your own time and/or paying for representation", I know you have never been in this position. I hope you never are.


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