Although it can seem like the Internal Revenue Service picks returns to audit at random, the agency uses special software to calculate the chance that you have made a mistake on your return. Unreimbursed job expenses can raise your audit risk score significantly because taxpayers often try to use personal costs as business expenses. You can keep non-reimbursed expense under a certain percentage of your income to limit your audit risk, but you should always claim legitimate expenses.
The IRS does not reveal the exact weight of variables used in its Discrimination Function software, only that it increases a taxpayer's risk score when deductions exceed a certain percentage of income or the average ratio deductions to income for similar taxpayers. Unreimbursed employee expenses, such as a home office and uniform fees, should not exceed 44 percent of gross income, according to Frederick Daily of "Surviving an IRS Tax Audit."
The 44 percent figure cited by Daily is an average of taxpayers from across the nation. The IRS formula uses a deduction to income ratio based on your demographic data, such as profession and location. If taxpayers in your area and in a similar line of work only deduct an average of 30 percent of their income on Schedule A, for instance, using 44 percent as your limit can increase the score the software gives you.
If the IRS audits your return, it will only investigate items that are "significant." The notion of significant depends on the comparative size of your deductions and their relevance to your profession. For instance, if you are a freelance writer, the IRS would probably look at a deduction for the business use of a boat with suspicion. The IRS will also look for personal expenses claimed as a business expense. For example, deducting interest payments on a business credit card looks unusual on Schedule A because the card might actually be for personal use.
Reducing Audit Risk
Take any unreimbursed employee expense as long as you can prove it is work-related. This means keeping receipts and a log of why and when you incurred the expense. Your records must be contemporaneous, so you cannot recreate records, such as by pulling previous bank statements. Also, review your prior year tax return. If non-reimbursed employee expenses were 5 percent of your income last year, a jump to 30 percent this year might look suspicious.