Hi and welcome to our site!There is NO contradictions - just because that payment was reported - doesn't mean expenses are deductible.Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit.Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.The statement above is based on the federal law - see here - http://www.law.cornell.edu/uscode/text/26/262a) General ruleExcept as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.
Thus, the fact the IRS has not questioned your deduction doesn't mean much - they have three years to audit the tax return - and assess additional tax liability.However - if these are not personal - but business related expenses - such expenses indeed may be deducted - and you may address the issue by providing supporting documents and explanation for business purpose of these expenses.
You are correct - if you hire a house keeper and pay for services - that is income to that house keeper and you as a payer might be required to report that payment.However - that doesn't mean you may deduct such payment.Reporting requirements for payments and deducting such payments are two different issues.Publication 15 that you referenced addresses reporting requirements - but it says nothing about deducting such expenses. Still the federal law we mentioned above states that personal expenses are not deductible - and that statement is valid for both federal and state levels.If these are personal expenses - we may not deduct them unless such deduction specifically allowed by the law. For instance - the law allows to deduct personal mortgage interest expenses - but there is no statute which allows to deduct a housekeeping expenses.
Sorry - I am here
Unfortunately - your situation doesn't leek good...In general - you may amend your past tax return - and there would be additional tax liability, penalties and interest charges.
That is true for both - federal and state tax returns,What you might want to consider - the statute of limitation for 2010 tax return would generally run out on Apr 15, 2014 - three years after the tax return was due. So - if the IRS would not send you an assessment letter before that date - they will not be able to assess additional liability for that tax year after that.
The best path forward might be to ask the IRS to abate penalties, however it would be very unlikely that interest charges are abated. File a form 843 -http://www.irs.gov/pub/irs-pdf/f843.pdf to request the "accuracy related penalty" be abate based on reasonable cause. If you provide the reason like "I forgot" - I do not think it will be considered as reasonable - so be careful when prepare an abatement request. If you have a health reasons - most likely it would be accepted.Here are instructions - http://www.irs.gov/pub/irs-pdf/i843.pdfIf the IRS accepts your reasons as reasonable - and agrees to abate penalties - at least part of the issue would be resolved.
States are usually more more reluctant for abatement requests...But if the amount of additional tax liability is substantial - you might consider having someone representing you with taxing authorities. Unfortunately - there is no simple and easy resolution.You might expected a different answer... please do not shoot the messenger.
That would be your choice. Please be aware that state audit will be available for the IRS as soon as it is completed - so they may follow.