Taking the deduction for your home is still a flag. The idea with the IRS is to stay under the radar, take only reasonable and justifiable deductions, and have lots of paperwork to back it up. There's a reason they put a little checkbox asking whether you took this deduction. The test is that the space is used 100% of the time for business, and cannot possibly be reconfigured easily to another , personal use.  And they WILL come and look, and once that auditor comes to your house, he's not going back with a "no change". He's got to pay his way..In an audit situation, the auditor will usually try to cut a deal on stuff that would take too long to deal with on a piece by piece basis ( i.e petty cash receipts), but the home deduction is all or none, and they will give you none, and it's up to you to pay a lawyer to defend it. And if you think that you're safe because you've gotten away with it for 3 or 4 years, you're wrong. Most full audits take a few years to wind through the system, and once they find it in one year, they will go back to the others. I've been there and fought these battles, and they are not worth the trouble and money. The best advice I could give is to incorporate. As a sole prop, I'm a big target. As a corporation, I'm lost in the crowd- just where I want to be.

I agree with most items here except with the incorporate advice relative to audits. I've been audited as both sole proprietor and corporation. Same ramifications with both types. As stated above they will find something to pay for their visit and to justify their selection of your books to audit. I suspect from my observations during audits that the agents for the corporate returns are even more aggressive. You may or may not have less of an audit chance as a corporation.
In my experience the few dollars saved with questionable deductions--meaning any red flag or even pink flag deduction--even after eventually being held as justified will never equal the direct costs of "hosting" agents in your home or office. Prior years records will come into play as well as countless hours spent accumulating records they order you to produce. Each audit in my case cost me thousands of dollars just to prepare for. Don't kid yourself that you are just small potatoes with minimal exposure. Once that audit is instigated if you have any brains at all you will hire professional help to get you through the process with minimal damage.

I challenge anyone to justify the "savings" of any red flag deduction with the IRS with the possible costs (financial and mental) of defending it.

Really good advice Jim and Lou.  Thank you both for posting your experiences.

I am really worried that I may be being audited because of the agencies sending 1099s on my social # and my claiming the income on the return for my S corp.  So far they are taking 45 days to look closer at my return.

Now that I dissolved my corp (hassles NOT worth it IMO) I will be back to sole proprietor status.

I have been taking the home office deduction, but I doubt what I've been saving is worth the red flag.  Probably won't be taking that anymore.

Any opinions on Sole Proprietor vs LLC vs S-Corp, etc?

Filing as an S-corp to reduce self-employment taxes this year saved me a bundle.

As long as you can show that you did not hide income, you won't have a problem. They will first send you a letter and give you a chance to show where the income was reported. You just have to show the S corp return to prove the income was reported. That can all be done by remote control.

Thanks Jim.  That is a relief.  I definitely accounted for all income - 1099 and otherwise - on my corporate return.  They haven't yet asked me anything or given me a chance to explain.  Just the ominous "We're going to take 45 days to look over your return" letter.   

Stop the madness!

www.fairtax.org

Quote from: dehooks on April 18, 2011, 19:17

Stop the madness!

www.fairtax.org

Really. Think of all the thousands and thousands of hours we have spent this year keeping records only needed for the tax collectors and then filling out those all those forms. When we could have been taking photos and making illustrations! And the money spent to hire accountants. All wasted. :'(

All of that is eliminated with this system.  No more worrying about April 15th.  Everybody pays their fair share of taxes, including the wealthy and illegal immigrants.  In this system, even people who receive income illegally will still pay taxes.  There's no way to game the system. 

Quote from: michaeldb on April 18, 2011, 19:25

Quote from: dehooks on April 18, 2011, 19:17

Stop the madness!

www.fairtax.org

Really. Think of all the thousands and thousands of hours we have spent this year keeping records only needed for the tax collectors and then filling out those all those forms. When we could have been taking photos and making illustrations! And the money spent to hire accountants. All wasted. :'(

All of that is eliminated with this system.  No more worrying about April 15th.  Everybody pays their fair share of taxes, including the wealthy and illegal immigrants.  In this system, even people who receive income illegally will still pay taxes.  There's no way to game the system. 

It looks like buying used and under the table would game the system. I imagine that it would pretty much crush new home sales too. Does hiring labor require that 23% - if not that could really boost hiring a photographer instead of buying images.

Not that there aren't plenty of problems w/ the current tax code and implementation. With most any changes, someone would benefit and someone would lose. I expect any changes to be according to the golden rule - those with the gold make the rules.