Common Tax Myths

This is one of the new chapters in the 2018 edition of Everyday Taxes (coming out soon).  It may seem like I am just pimping for the new book since it keeps referring to information in the book, but that's just because I copied it right out of the book, which links internally to chapters on the subject, and I was too lazy to link to a website.

There are a lot of myths and confusion out there, and I’m going to try to clear a few of them up.  Some are a big deal, others are a bit nitpicky.

1. You do NOT have to buy a new house in order to exclude the gain from the sale of your personal residence.  I have a whole chapter on it in the book, but, basically, if you owned and lived in the home for 2 of the last 5 years, never rented it out and never used it for a business, you can exclude $250,000 of gain ($500,000 if Married Filing Jointly and both of you meet the timing rules) regardless of what you do after selling.

2. Moving up tax brackets is a good thing.  It means you made more money.  Only the part of your income that is in the higher bracket is taxed at the higher rate, everything else is taxed at the lower rates based on what bracket THAT income falls into.  The only real trick about crossing tax brackets is when your household has multiple sources of income.  If all your (and your spouse’s) jobs fall into the 12% tax bracket, but together you hit the 22% bracket, your withholding is not going to keep up very well.  This is a source of endless frustration for people using software that updates their refund constantly.  I talk to a lot of people who put their income information into the software, and then freak out when the really big refund plummets as they put their spouse’s income in.  The refund is only useful as a number when you are done – don’t look at it along the way.

3. Deductions are nice, but not spending money on things you don’t want or need is better.  Just because you can deduct something doesn’t make it a good idea – you are only getting pennies on the dollar back in taxes.

4. Income tax is voluntary, 16^th amendment was never ratified, income tax is tax is illegal or any other scheme that avoids taxes.  The IRS refers to them as frivolous tax positions and you can be fined just for using the arguments in IRS proceedings.  Most of these have been thoroughly litigated through Federal courts, many all the way to the Supreme Court ruling on them or refusing to review a lower court ruling against them.  Here is the IRS page on the subject: https://www.irs.gov/pub/taxpros/frivolous_truth_march_2018.pdf

5.  Individual Retirement Accounts (IRAs) are not an investment, they are a shelter AROUND an investment.  This may not seem like a big deal, but it matters because a lot of times people open IRA’s and think that means they have worthwhile investments in them.  If you open it at a bank, this will often be a money market account or Certificate of Deposit which is wholly unsuited as a retirement investment for most people.  The process of opening an IRA involves setting up the account AND determining what an appropriate mix of investments is for the account.  You can have almost any common investment in your IRA: Stocks, bonds, mutual funds, publicly traded partnerships, exchange traded funds, closed end funds and much more.  An IRA should be opened with the help of a competent financial professional or after you have done a lot of personal investment research.  You should also consult your tax professional to make sure there aren’t income limitations regarding how much you can invest.  

6.  Head of Household means something different for taxes.  In life, you can be the head of your household, but it doesn’t mean that’s your tax filing status.  For taxes, Head of Household means you are unmarried and are taking care of a certain type of qualifying child for a certain amount of time.  The rules are covered in the Filing Status chapter of the book.  Starting on 2018 returns, the IRS is going to be taking a harder look at Head of Household and fining tax preparers who don’t exercise due diligence when determining if their clients can file as Head of Household (this is a big deal, because in most cases I can believe anything you tell me and not get in trouble.  There are very few things that I can be fined for if I’m not being suspicious enough regarding what a client tells me).

7. Social Security is taxed in a weird way.  Also, if you retire before reaching your full retirement age, you have to pay back Social Security if you make too much money from a job or business.  People confuse these things repeatedly.  Up to 85% of your Social Security can be subject to tax if you have other income.  I cover the details in the book.  This calculation of taxability applies no matter how old you are.  Having to pay back Social Security if you make too much money only applies when you are below full retirement age, and the numbers are a lot stricter (though this is NOT my area of expertise).

8. Tips are taxable income.  You are responsible for reporting them to your employer so it can be included on your W-2 and have various taxes withheld from your paycheck to cover the tips taxes.  Even if your employer doesn’t insist that you report them (or actively discourage you from reporting them) does not relieve you of responsibility to report them.  I’m not your Mother or Father, so do what you want, but recognize that failing to report tips is tax fraud and may be other types of fraud if you receive other benefits or subsidies based on your income.  

9. This is pure tax professional nit picking here: You file a tax RETURN to determine the amount of REFUND you get or your BALANCE DUE that you have to pay.  The money you get is not your return it is your refund.  You only get a refund if you have too much in taxes withheld from your paycheck and/or you qualify for a refundable credit such as Earned Income Credit, American Opportunity Credit, Electric Vehicle Credit, Solar Credit etc.