7 Tax Myths and How Al Capone Could Have Stayed Out of Jail

Hey everybody!  I’ve been following some blogs, subreddits, and other news sources and wanted to give an explanation debunking the top tax myths I hear on almost a daily basis.  This advice is based on my understanding of the US Tax Code.  Although I am a CPA, I am by no means a tax expert and these items should not be taken as tax advice.

“Making more money will push me into a higher tax bracket!” (Also knows as my SO should stay home with the kids because his/her salary would just be eaten up by taxes).
This is a common misunderstanding of how our tax structure works.  If you are in a 30% tax bracket, that does not mean that all of your income is taxed at a rate 30%.  It means that the highest rate any of your income is taxed is 30%.  For a single person, it looks like this (2013 rates):

10% on taxable income from $0 to $8,925, plus
15% on taxable income over $8,925 to $36,250, plus
25% on taxable income over $36,250 to $87,850, plus
28% on taxable income over $87,850 to $183,250, plus
33% on taxable income over $183,250 to $398,350

Also, it’s important to note that taxable income is not the same as salary.  There are several ‘above the line’ deductions, such as student loan interest, standard deductions, personal exemptions that decrease the amount of your taxable income.

“Everyone should donate to charity because they can write it off on their taxes.”
Although there is an option to write off donations, it is only available to indivduals that itemize their deductions.  This means that you don’t take the standard deduction.  The standard deduction depends on your filing status (more on that later) and is as follows for 2013:

Single: $6,100
Head of Household: $8,950
Married Filing Joint: $12,200
Married Filing Separately: $6,100
Qualifying Widow/Widower: $12,200
Dependent: $1,000-$6,100

So, if you can’t itemize more than this amount (mortgage interest, health care expenses, tax prep fees, and donations are the biggest items) then it is in your advantage to claim the standard deduction.  This means that the old bed sheets and flannel shirts you gave to Goodwill just came out of the goodness of your heart.

“I am the HEAD of MY household, so that must be my filing status.”
This is a very advantageous filing status, so I understand why people want to make it apply for their situation.  For most people; however, this will not be the case.  Head of Household only applies to unmarried individuals that pay over half the cost of maintaining a home in which at least one qualified person lives for over half the year.  Basically, a single mother or father.  This can also apply to a person that cares for their dependent relative.  Otherwise, you’re stuck with us single folks.

“I should get married just for the tax break!”
If one spouse works and the other stays home, this may be the case (called a marriage bonus).  However, in the 21st century, with both spouses generally working, there is actually a marriage penalty.  This is due to the fact that rates, deductions, and phase out amounts are not a simple 2x calculation for a married couple (versus 2 single individuals).  For example, the 25% tax rate for single individuals stops at $87,850 adjusted gross income.  However, for married filing jointly, it stops at $146,400.  This results in $29,300 being taxed at the next bracket for a married couple.

“Fine, then I’ll just do married filing separately”
Nope.  This is the worst possible filing status.  Lower deductions/exemptions, higher tax rate brackets.  Pretty much the only reason to do this is if your husband/wife is making money Breaking Bad style and not claiming it on their tax return (also known as tax fraud, and it’s how Al Capone was thrown behind bars).

“Poor people don’t even pay taxes.”
No one pays taxes up to a certain amount each year (the standard deduction plus personal exemption).  For 2013, that amount (for a single filer) is $10,000 or (for a married filing jointly filer) is $20,000.  So, if you make under that amount, you wouldn’t pay any federal income taxes.  But seriously, if that’s what you are making, you need the money more than our Let’s-Threaten-To-Shutdown-The-Government-Every-Year friends in DC need it.  You may even get a refundable credit (meaning you get money back even if you didn’t pay anything).  However, you would still pay sales taxes, excise taxes, property taxes, fuel taxes, etc.  As mentioned in my I Pay How Much In Taxes Post, it is pretty much impossible for anyone to get away with paying NO taxes.

“I pay taxes on both sides of the road, so I should get to drive like a jackass.”
I can’t argue with this logic, but don’t be this guy.

What tax myths have you had to bust?  Anything you believe to be true that you’d like me to research?

Flickr Image Source: “Tax’ by 401(K) 2013

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Posted in Money Management

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