Many Tax Myths Still Have a Hold on Taxpayers
Sometimes a little learing is a dangerous thing. Just check with your clients. Many of them probably suffer under a number of delusions about taxes. Disabusing them of their beliefs can be troublesome for tax professionals.
“When you are dealing with something as complicated as income tax law, it’s not uncommon for misconceptions to arise,” said David Bergstein, CPA, a tax analyst for CCH CompleteTax.
Maybe this list from CCH CompleteTax, an online tax preparation and e-filing solution for the do-it-yourself taxpayer, will help. It’s based on a CCH-commissioned Harris survey.
Myth #1: A home seller can take a capital loss write off for a home that sells at a loss.
Only 8 percent of respondents to the CCH CompleteTax survey answered correctly that a homeowner cannot write off a loss if they sell their home for less than they’d paid for it. Three in 10 respondents believed incorrectly that a write off could be taken for a loss and most – 62 percent – don’t know which answer to believe.
Given the slumping housing market, many home sellers may wish they could take a capital loss on their home, but it’s not allowed.
“Under tax law, your home is considered personal property, and you can’t take a deduction for personal property that you sell at a loss, whether it’s your car, a computer, your house or any other personal property,” said Bergstein. “This is particularly hard for some taxpayers to swallow because if they sell their home for a gain, they may have to pay capital gains taxes.”
Myth #2: Sales tax and state income tax are not deductible.
How much myth and how much fact this is depends on which year you’re speaking about…and could change, again, before 2008 ends. The tax code related to deducting sales tax or state income tax has caused a lot of confusion through the years. It used to be that individuals could deduct sales tax if they itemized. Then that option was removed. Starting in 2004 and renewed for 2006 and 2007, the option became that they could choose to deduct either their sales taxes or state income tax, but not both. For 2008, the law reverts to just being able to deduct state and local income tax, not sales tax, unless legislators extend the provision sometime this year.
As for what people believe, just 9 percent of individuals answered that either sales tax or state income tax, but not both, can be deducted from their federal tax return, which is the correct answer when filling out 2007 tax returns. Fifteen percent answered state income tax only can be deducted, which – at least for now – is the correct answer for 2008. But nearly one-third, 30 percent, responded incorrectly, regardless of tax year, believing you can deduct both sales tax and state income tax, neither tax or sales tax only. In addition to the large number of individuals that answered incorrectly, 45 percent don’t know which – sales tax and/or state income tax – can be deducted on their federal return.
“When tax code changes go back and forth like this, it makes it very hard for taxpayers not using tax software or a professional tax preparer to keep the rules straight year to year, and that could be costly in missed deductions,” said Bergstein.
Myth #3: The recipient has to pay taxes on gifts or inheritance.
Only 11 percent answered correctly that individuals receiving a gift or inheritance generally do not have to pay income tax on the proceeds, according to the CCH CompleteTax survey. Nearly one-half, 47 percent, answered incorrectly that the recipient owes taxes and nearly as many, 42 percent, don’t know the correct answer.
“Usually, gifts or inheritance that you receive are exempt from your federal income tax, with the donor responsible for paying the federal gift tax or the decedent’s estate paying the federal estate tax,” said Bergstein, adding that it is possible, though very unlikely, that the IRS could try to get the recipient to pay the tax if the donor or the estate did not.
Myth #4: Filing an income tax return electronically will trigger an audit.
Fewer than one-half of individuals (43 percent) realize that this is a myth, while 52 percent don’t know whether it’s a myth or not and 5 percent still believe e-filing a tax return increases the likelihood of an audit compared to mailing in the tax return.
“The IRS has clearly tried to communicate that there is no greater chance of being audited if a taxpayer e-files,” said Bergstein. “The irony is that if you manually fill in a return, it’s more likely you will leave out information, which is a sure-fire way to catch the attention of the IRS.”
Myth #5: Older children who are working cannot be claimed as dependents.
When asked if a couple could claim their 18-year-old child who is working and going to school part-time as their dependent, 49 percent of respondents to the CCH CompleteTax survey answered correctly that they can claim the child so long as they provide more than one-half of the child’s financial support. However, 20 percent answered incorrectly and an additional one-third (31 percent) don’t know if the child could be claimed as a dependent.
“Just because your child is working or is 18 years old isn’t enough to disqualify them as your dependent. Even if your child is a budding entrepreneur earning a nice paycheck or comes into a sizable inheritance, so long as you are providing more than half the child’s support, you generally can claim them as your dependent,” said Bergstein.
Myth #6: People should not file a tax return if they do not owe anything.
Most individuals appear to be catching on to at least one myth, with more than three out of four adults (77 percent) surveyed recognizing that you should file a tax return, even if you don’t owe anything. Only 8 percent answered that you should not file a return and 15 percent did not know which an individual should do.
“It’s great news that people are recognizing that filing a tax return when you don’t owe any money can be a good idea. For example, you may be able to claim credits, like the earned income tax credit, or get a refund if you’ve paid more than you owed in taxes,” said Bergstein. “It’s even more important this year because filing a federal income tax is the first step in making sure you receive any tax rebate you may have coming.”
