My wife works from home because her company does not even have an office. My question is how the heck would they know if nothing but this job is done in the home office? Does it basically improve the chances of an audit, and during the audit they go in your house and look at your office to see if there are any personal files in the office?
It would generally be too costly to send IRS agents to your house to see if you play World of Warcraft from your home office. Generally, people tend to be honest during interviews, though. So during an audit, they'd just ask you if you do anything non-business there. They might get tricky and say things like, "Is there another computer in the house?" "Do you ever let your kids use that office for homework?" "Other than your desk and computer, what else is in your office?"
Assuming you don't use the simplified method, they have been known to ask for house plans/records that show the square footage of your house and interior. They might determine if your % used for home office is reasonable in relation to the total usable square footage in your house, and then from there it's a matter of making you prove the related expenses.
The Simplified Method for determining your home office deduction maxes you at $5 x 300 sq ft. It's called a "Safe Harbor." Which translates to "auditing your home office is costly for the IRS, so here's a method that we don't have to audit."
It's not the home office that correlates with high audit rates - it's that people have traditionally abused the home office. 50% of my house is my office! That means every single house-related expense is deductible! Time to deduct 50% of my kitchen renovation!
When you push a home office deduction (or really, any deduction) outside what is considered the reasonable norm, it will present an audit risk.