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Top Twenty Tax Myths and Why They’re Wrong—Part 1

Feb. 11, 2021, 9:46 AM

You can hear a lousy tax take almost anywhere from your hairdresser to the grocery store.

Today, with a smartphone and a social media account, taxpayers have a platform to share that advice almost immediately. And the more it’s shared, the more legitimate it may appear to taxpayers.

Countering bad advice, especially during tax season, is crucial. Here’s a look at some tax myths—and why they’re wrong.

  • Filing taxes is voluntary. Most tax myths have some basis in truth, which is why they spread so easily. It’s true that the US tax system is characterized—even in IRS publications—as voluntary. But context is important: our “voluntary” tax system means that taxpayers complete returns and calculate the tax due, instead of having the government do it for you. Filing a tax return may involve making some choices, but the requirement to file income tax returns isn’t voluntary. Tax filing requirements are clearly explained in the tax code in Sections 6011(a), 6012(a), and 6072(a).
  • If you file for an extension, you don’t have to pay your taxes until you file your return. It’s so easy to get an extension that some taxpayers believe that they don’t have to pay until they file. That’s not true. The requirements for requesting an extension can be found at Treas. Reg. 1.6081-4(b), and the language making clear an extension of time to file won’t extend the time to pay the tax due is in the Treas. Reg. 1.6081-4(c). Failure to pay on time can result in penalties.
  • You can choose your filing status. For federal purposes, you can select from one of five filing statuses: Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Widow(er) With Dependent Child. It’s often confusing for taxpayers when a life event—like a marriage or divorce—happens during the year. It feels like that should result in a choice. But for federal income tax status, marital status is determined as of the last day of the calendar year. If you are married on December 31, you are considered married for the year. If you’re not married on December 31 because you were never legally married or you were legally separated or divorced according to the laws of your state, you are not married. It doesn’t matter what happens in between.
  • You don’t have to pay tax if you’re paid in cash or cryptocurrency. It’s easy to tell how this myth got started: There’s no paper trail. Payment by check or credit card is easy to trace because it ends up on a bank statement. You don’t always deposit cash in the bank, and you may move cryptocurrency without reporting systems in place. But just because it’s not on a bank statement doesn’t mean that it’s not reportable or taxable. I was once paid in children’s toys, and I had a client who was paid in copper wiring. Income is income, no matter how you’re paid.
  • You don’t have to pay tax on Social Security. If Social Security retirement benefits were 100% taxable, that amount would put most taxpayers over the filing threshold. So Congress came up with a formula to exempt taxpayers who rely solely on those benefits: If your only source of income is your Social Security check, it isn’t taxable. But since everyone knows someone who doesn’t need to pay tax on Social Security, that has spiraled into the idea that no taxpayers pay tax on benefits. That’s not true. Once you reach retirement age, whether your Social Security benefits are taxable depends on your filing status and how much other income you receive.
  • It’s better not to make more money because you’ll pay more taxes on all of your income. The notion that increasing your income increases your overall tax rate stems from a misunderstanding of marginal tax rates. Your marginal tax rate is your top tax rate: It’s the rate you’ll pay on the next dollar of taxable income. For federal purposes, rates go up as income goes up, but—and it’s a big but—everyone pays the same rate for the same income. When you hit a higher tax rate, like 37%, you only pay the higher rate on income over the threshold amount. You don’t pay 37% on all income. The result is a blended tax rate, sometimes referred to as your effective tax rate.
  • You can claim the home office deduction as an employee because of the pandemic. Many of us are working from home during the pandemic. In some cases, your employer may require you to work from home. That feels like an excellent reason to deduct the cost of the internet and other home office expenses. But it’s not. As a result of the 2017 tax law for the tax years 2018 through 2025, employees who work from home can no longer claim the home office deduction. There is no hardship exemption or pandemic waiver and the reason you are working from home doesn’t matter.
  • In a volatile market, you’ll owe tax on your stocks or cryptocurrency if the value goes up or down significantly. Stocks and cryptocurrency go up and down: It’s part of the game. Does that mean that you have a tax consequence? Not unless you have a realized gain or loss due to a taxable event, like a sale or a transfer. If you only have a gain or loss on paper, for federal income tax purposes, it doesn’t mean anything. There are typically no tax consequences to you for an unrealized gain or loss.
  • Expenses are always valuable tax deductions. Tax deductions are useful because they reduce your taxable income which reduces your tax due. That’s a good thing, right? But there is often a rush to lard up on expenses simply because they generate deductions. Don’t be fooled: You’re still spending money. Even if you can deduct the costs, they should be ordinary and necessary—that’s important for tax and business reasons. If you save 25% in tax due to the deduction, you’re still out of pocket as in 100% in costs less the 25% tax savings. Be sure that it’s worth it before you spend.
  • If you file for an extension, your chances of getting audited will go up. I’m not sure how this myth got started, but the data doesn’t support it. In fact, some practitioners—including me—suggest that an extension could actually lower your chance of an audit. It’s better to file a complete, accurate return on an extension than a rushed, sloppy return just to meet the due date. And extensions are easy: You don’t even have to explain why you’re asking for one. The IRS understands that there are legitimate reasons why taxpayers may need more time to file.

If you don’t see your favorite lousy tax take, stay tuned for Part 2 of this column.

To contact the reporter on this story: Kelly Phillips Erb in Washington at kerb@bloombergindustry.com

To contact the editors responsible for this story: Rachael Daigle at rdaigle@bloombergindustry.com; Yuri Nagano at ynagano@bloombergtax.com

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