Opening up that letter from the Internal Revenue Service (IRS) can make your heart skip a beat. The federal agency has contacted you to let you know that you are the subject of a tax audit. At first you are concerned. You worry that you may have made a mistake. But then you remember you kept a file with meticulous records, you have receipts to back up your claims. You should be fine. Right?
Unfortunately this common assumption is not always true.
The problem with substantiation
To put it simply: substantiation is not enough. Substantiating, or clearly proving, that you paid the bill, that the amount is accurate, that a receipt is present to back the claim is only one step in a many step process to fight the IRS in the event of an audit. The taxpayer must also show the IRS that they had good reason to deduct the expense.
How can you prove you are justified to claim the expense as a deduction? There are some forms of evidence the IRS will generally take into consideration. Examples can include a diary or trip sheet that outline the time, place and purpose for the expense. This information, in addition to the actual receipt, will better your chances of success in your fight against the IRS.
Substantiation in the age of COVID-19
Now, let us take a moment to apply this information to future tax filings. During the current coronavirus pandemic, it is highly likely that you have spent time working remotely. Does that corner in your home where you set up a laptop now qualify you for a home office exemption? And if so, how do you make sure you have all the information you need to back up the claim if the IRS asks questions about it in the future?
The answer, like many things in the legal world, is that it depends. Generally, the IRS requires that the space claimed towards a home office deduction be “integral to the conduct of the taxpayer’s business.” A kitchen nook or corner in the living room is generally not enough unless the taxpayer can prove that this area was the principal place of business. Not an easy task. The agency generally requires the space be a separate and identifiable space used solely for business purposes — which, if the case heads to court, can come down to the judge’s discretion.
To further complicate matters, it is possible that lawmakers may pass additional laws that result in tax breaks for employees and entrepreneurs that are using home space as office space. As a result, it is generally wise to seek additional counsel when attempting to determine if your space will meet the requirements at the time of the tax filing.