Don't Fall for These 20 Common Tax Myths
To say the U.S. tax system is confusing is an understatement, so it's no wonder there are many misconceptions about the rules. The good news is that most people make less than $100,000 in a year and have no income other than their paychecks, so they can fill out the comparatively brief and very direct short form; almost everyone who uses the 1040EZ can fill it out themselves. For everybody else, though, the baffling mysteries of the tax code prevail, and can ultimately cost money. To help unravel some of the perplexities of the system, here are 12 common tax myths debunked. It might save money and sanity when the deadline rolls around.
No, it isn't. It's mandatory, although compliance is voluntary -- only because the Internal Revenue Service can't follow everybody in the country around to make sure they file. There is, in fact, a law (Title 26 of the U.S. Code, ratified by the 16th Amendment to the Constitution) that requires every individual with taxable income to file. While some people make too little to file, in general everybody with an income is expected to send in a return.
Maybe true, maybe not. The IRS cares not about the educational status of citizens but about their income. If students have more than $10,400 in income or $400 in self-employment income, they need to file. Even if working students earn less than the filing minimum, it's a good idea to file, because a refund may be due. But students under 24 who have less than the minimum filing income may be claimed under their parents’ taxes, and therefore, should file with their parents.
People who work at home can claim the part of their home in which they work as a deduction, that's true. But people who work in an office during the day and sometimes bring work home do not have a home office, according to the IRS, even if they have a dedicated place at home from which to work. The home office deduction applies only if the home is the principal place of business, which means the taxpayer must be self-employed.
Nope. There is no such thing as an automatic audit. There's no way to game the system to avoid one, either. Fraudulently claiming a home office, very high self-employment income, or taking more business deductions than income from self-employment are red flags, though. And there are a few scenarios that might trigger an audit: major changes in income or charitable giving, missing forms or files or numbers that don't add up, claiming business expenses for a hobby, and having an overseas bank account or foreign assets. The best way to avoid an audit is to be careful and honest about deductions.
The IRS is looking for discrepancies, not income. So an audit could happen no matter how low a filer's income. In fact, people with income under $25,000 are slightly more likely to get audited if they claim an Earned Income Tax Credit, according to the Tax Foundation. The IRS is extremely short-handed now, so everybody’s chance of getting audited is pretty low -- in fact, only 0.70 percent of all 2016 individual returns got called for an audit.
It is often a good idea for married people to file jointly because they qualify for more tax credits that way, but there's no rule that says they must. Filing jointly means a bonus if there is a big disparity in income, or if joint income is less than about $150,000. Once taxpayers get above that level, there is actually a penalty for filing jointly, because they get pushed into another tax bracket. There are other scenarios in which filing separately is a better deal, such as when one spouse has a lot of medical deductions, says the Motley Fool.
Efiling will probably be mandatory pretty soon. In fact, tax preparers must efile. There are still some technophobes who believe it is somehow not as effective or safe as mailing in a paper return, especially with sensitive information inside, but H&R Block says it is safer to file returns electronically, with less susceptibility to human error from having an IRS employee re-enter tax information into the system. Refunds are deposited more quickly, and it's possible to have funds withdrawn directly from a bank account when money is owed -- no check-writing needed.
If taxpayers owe money to the government, it still needs to be paid by April 17 this year to avoid potentially costly interest and penalties -- even if an extension is filed. The failure-to-pay penalty is half of 1 percent of the money owed, which applies each month starting April 18. There is no stigma attached to filing for an extension -- the government does not ask for a reason, just the proper filing and at least 90 percent of the money owed. Of course, when the full return is filed, anything still owed to the government must be paid.
Ah, if only this were so. But it's not. Federal tax laws require that any tips over $20 in any given month should be reported to the employer, which includes tips from customers as well as any pooled tips. If the employer doesn't report tip income for workers, it's important to keep track of tips independently and file Form 4070 (or Form 4137 for unreported tip income). If part of the tips received are pooled, the person getting the tip needs to report only the part that was kept.
As usual, the IRS doesn't care about working status, just about income. But the cutoff for having to file is somewhat higher for people over 65 than for younger people. For single seniors, the cutoff is $11,850; if both spouses are 65 or older and filing jointly, the cutoff rises to $23,300.
Investors who lose a lot of money might figure they can deduct those losses against their income and not have to pay anything. Well, maybe. First of all, to take any deduction at all, the stocks have to be sold, making them a capital loss. And while it is possible to deduct capital losses, $3,000 is the maximum. That's usually not enough to cancel out other taxes. Capital losses over $3,000 per year can be carried over to other years, though, and deducted against either capital gains or income.
Technically this is true, insofar as the more that's withheld from the weekly paycheck, the more is likely to be refunded in April. But it's not a sensible strategy. People who do this on purpose are giving the government an interest-free loan and missing out on the chance to spend their own money or earn interest on it. A much better idea would be to put the money in an interest-bearing account, even if the interest is only 1 percent. That way, if it turns out the government is owed money in April, you have still made something.
It’s true that recent changes to the standard deduction might raise it high enough to make it no longer worthwhile for many people to itemize deductions. In fact, many of the items that used to be deducted will no longer be eligible. But this does not apply to 2017 taxes. In addition, there are people who are still going to benefit by filing itemized returns, because their deductions total more than even the new standard.
The IRS has three years to audit taxes, so the ones that get filed for the 2017 tax year may not get audited till 2020. If an audit does come though, it will be in letter form, not any other way -- not by phone, text, or email. Anything else is a scam.
In most states, Social Security income is tax-free. With federal taxes, though, it depends on how much additional, or “provisional” income there is. Provisional income is adjusted Gross Income, minus Social Security, plus 50 percent of benefits and any tax-free income, such as from municipal bonds. When that is less than $25,000 for a single person or $32,000 for a couple, no taxes are owed. With more than that, up to 85 percent of Social Security benefits can be taxed.
Estimated taxes need to be filed quarterly, as long as the amount owed is more than $1,000. Paying them at the end of the year is the same as paying them late, which can incur stiff penalties. It’s also a bad idea, tax preparers note, because the likelihood of spending that money is greater.
It’s actually less than that. The medical deduction rate is now 7.5 percent. This is one of the few areas in which the new tax law is retroactive to the 2017 tax year. It will also apply for the 2018 tax year, after which it will go back to 10 percent. Additionally, health insurance costs are still a deductible expense in most cases.
Not so fast. Effectively, the individual mandate, which charges a penalty to everyone who did not have some form of health insurance, was repealed. But this does not go not effect until 2019, so people who do not get insurance from their employer and can afford to buy it can still face stiff penalties if they do not. In 2017, the penalty was the higher of $695 for each adult or 2.5 percent of the household's AGI, and $347.50 for children under 18. The penalty is capped at $2,085 for a household, paid when the tax return is filed. If additional tax is owed, the penalty is added to the amount due. If a refund is due, the penalty is deducted from the amount owed the taxpayer.
Most of the time, this is not true. A taxpayer buying a property for the purposes of rehabbing it and selling it must hold it for a long time before it can be considered an investment and therefore taxed as a long-term gain, which has a lower tax rate than a short-term gain. To claim a long-term capital gain, the property must be held for investment purposes, which means it needs to be rented out for at least a year.
For the 2017 tax year, this interest on a loan or line of credit of under $100,000 is still deductible. Technically, as of 2018, that interest will no longer be deductible, but there are still questions about how the law will actually work. “Acquistion indebtedness” -- that is, a loan that was taken out to make a substantial improvement on a house -- might still be deductible in 2018.