Income Tax Myths

As we all know, rumors and myths exist in many aspects of life, and unfortunately the area of tax law is not immune.  Following are some of the most common misinterpretations and untruths I have encountered in my career as a tax preparer.  I hope you find this list educational as well as entertaining.

“All CPAs are tax experts.” – I figured I’d start this list with maybe the most common tax myth of all.  CPA stands for Certified Public Accountant, and the path to becoming a CPA is very difficult.  Among the requirements, one must pass a four-part exam administered by the state on accounting concepts and practices.  Within one of these four parts is a section on taxation.  Once someone becomes a CPA, he/she must participate in continuing education in order to stay current on accounting issues and topics; this education can be tax-related, but it does not have to be.  In practice a CPA may or may not choose to specialize in tax matters; he/she may instead choose to focus on auditing or financial reporting.  In summary, while most CPAs do prepare tax returns and many of them do specialize in tax law, the fact that someone is a CPA does not automatically mean he/she is a tax expert.  As a comparison, click here to read about the requirements for being an Enrolled Agent. 

“My child is a student, therefore he/she is exempt from income tax” – This one might be wishful thinking more than anything else, but it is definitely not true.  Being a student may entitle a taxpayer to certain deductions and credits, but it is not an automatic exemption from paying taxes; in fact, without looking at types and amounts of income a person earned, there are generally no automatic exemptions from income tax.  For example, a 9-year old child with a sizable savings account in his/her name could owe income tax if the account earned enough interest.  Or more commonly, a high school student earning money at a part-time job may owe taxes if the wages are of a certain amount.  Again, being or not being a student plays no role in determining whether someone owes taxes.

“If I don’t receive a tax form for income I earned, I don’t have to report it.” – All income is taxable unless the law specifically deems it as nontaxable.  Some instances of not receiving a form for income earned are not that big a deal, while others can be very serious.  For example, a financial institution is not required to issue a Form 1099 if you earn interest or dividends less than $10.  “Found income”, or treasure trove, is also taxable; this would include gold coins found in the attic of an old house or a dollar found while taking a walk around the block.  In all of these examples a person would not receive a tax form in the mail, but legally these are all forms of taxable income and are supposed to be reported.  On a more serious note, you may have earned significant income at a job but never received a W-2 or 1099-MISC; not reporting that income would almost certainly result in an audit.

“If I make a mistake on my tax return I will go to jail.” – Paranoia about what the IRS can and will do to taxpayers is quite common, but most of it is unfounded.  For a taxpayer to be imprisoned for a tax-related offense, the IRS has to prove willful neglect; in other words, a person would have to intentionally defraud the IRS.  Going to jail over a tax-related matter is actually very rare, but when it does happen it is memorable, which is why people think it happens more often than it actually does.  If a person makes a mistake on his tax return (which is very common), he may receive a letter in the mail from the IRS notifying him about the error; on the other hand, the IRS may never catch the mistake.  However keep in mind that if a taxpayer later discovers an error on his tax return that has already been filed, it is his duty to amend the return to correct the error.

“If my tax preparer makes a mistake on my tax return, he/she is liable.” – Speaking of making mistakes, this is a very common misperception about a tax preparer’s obligations.  It is the TAXPAYER who is liable for any errors on the return, not the preparer.  When taxpayers sign their tax return, they are stating that they have reviewed it and that to their knowledge it is true and complete.  If the IRS or DOR later finds an error that results in a bill to the taxpayer, it is the taxpayer who is solely responsible for paying it (which will often include penalties and/or interest).  A reputable preparer should offer to pay any penalties and interest that have been added to the amount due if the error is the preparer’s fault, but he/she is under no obligation to do so.  Now on the other hand, preparer penalties can be imposed if the IRS or DOR decides that a preparer has been negligent or fraudulent, but this is something completely different from an “everyday” error or omission.

“Getting a huge refund is great news!!!” – Well it’s better than owing, but if your refund is very high (i.e. into the thousands) then it means you are essentially loaning your hard-earned money to the government, and they don’t owe you a dime of interest.  Would they lend you money and not charge interest?  I doubt it.  Getting a huge refund could mean you are having too much withheld from your paycheck; in this case you should fill out Form W-4 to decrease your withholding and give it to your payroll department at work.  However, many people prefer to receive a large refund for any number of reasons.  A majority of people have come to associate tax time with receiving a large check or direct deposit, and so it doesn’t feel right to them if that does not happen (an extra $40 per paycheck may go unnoticed, but $1,000 “missing” from a refund can be very apparent).  Other people have poor saving habits and basically use the government as their bank account.  The bottom line is that from an economic standpoint the best possible outcome is a zero refund, but clearly this is easier said than done, at least on an emotional level.

“I can deduct anything I gave to charity.” – I don’t know how many times I’ve had to tell clients (much to their disbelief) that because of their specific tax situation, they cannot (or should not) deduct their charitable gifts.  Charitable gifts can ONLY be claimed if you itemize, which means instead of taking the standard deduction you choose to add up certain categories of expenses and deduct those instead because they will result in a higher amount.  Other examples of amounts you can itemize are medical expenses, state and local taxes, and mortgage interest.  Unfortunately if you do not have a mortgage, you probably do not have enough itemized deductions to be able to claim any of them.  Whether this is fair or not, it is how our tax system is set up, and quite often people don’t find out until tax time when they want to deduct an expense that they cannot. 

“I can deduct expenses related to my job.” – Employee business expenses used to be allowed only as an itemized deduction, which already prevented certain people from claiming them. However, since the Tax Cuts & Jobs Act was signed into law in 2018, this deduction has been completely disallowed. The only exceptions are expenses related to self-employment and school teachers (the latter of which is limited to $250 per year).

“My neighbor deducted _________ on his tax return, so I can too.” – You can fill in the blank with any expense you can think of, but it seems like everyone has a neighbor who is a tax expert.  This misconception often goes hand in hand with the previous two myths, where it is the neighbor who tells someone that they can deduct their work boots or their gift to the Red Cross, and then that person goes to a tax preparer demanding that the expense be included on the tax return.  Everybody has a unique tax situation, and there are many factors that create differences:  marriage, children, income level, types of income, and owning a home vs. renting are just a few.  All of these factors can contribute to what can/cannot be deducted, and in turn on how much of a refund someone gets.  The mere fact that a co-worker or neighbor claims they deducted a particular expense (whether they actually did or not is another question) does not automatically mean that you will be able to as well.

“People who work for the IRS or DOR don’t have to pay taxes.” – What follows is the end of an actual phone conversation between a taxpayer and me when I worked at the MA Department of Revenue (DOR) as a customer service representative:

Me:  “…unfortunately that’s the law.”

Taxpayer:  “Well why should you care?  You people don’t have to pay taxes.”

Me:  “Uhh, what?”

Taxpayer:  “You people who work for the government, you don’t pay taxes.”

Me:  “No sir.  We are taxed the same as everyone else.”

Taxpayer:  “Ha ha ha, yeah right.  Have a nice day.”

Just in case anyone else thought this was true, I can assure you it is not.  There is no special tax exemption for government workers.  It is true however that some state and city government workers do not contribute to Social Security because they have their own retirement system, so maybe that’s where this myth derives from.

“My gambling losses are more than my winnings, so I don’t have to claim any of the winnings.” – Gambling winnings of any amount are taxable, whether you receive a tax form or not.  Even if you lost more than you won, the winnings are to be fully reported.  Gambling losses are allowed up to the amount of winnings as an itemized deduction, which means the winnings are reported in one place and the losses in another; they are never combined and reported as a net total on a tax return.  People who don’t itemize are often disappointed (and sometimes angered) to learn that their stash of losing scratch tickets will do them no good at tax time.

“The federal government taxes my state refund too???” – This is more of a misunderstanding than a myth, but I’ve heard it enough that it seems worthy of including here.  When people itemize on their tax return one of the deductions allowed is for state and local taxes, and one of the most common types is the state tax withheld from paychecks.  Itemizers are allowed to deduct the total state tax withheld for the year (so for example, they will deduct state tax withheld in 2011 on their 2011 tax return, which they are filing in 2012).  When these same taxpayers file their state tax return they are also reporting this same amount of withholding, not as a deduction but as a credit against tax due.  Here is where the confusion comes about:  if there is a state refund, the taxpayer has essentially been given a double benefit: 1) the entire amount of state tax withheld, or paid, was deducted on the federal return, and 2) the taxpayer received a refund of some of that withholding, meaning that portion was not actually paid.  This is why itemizers must report their state refund on their federal return the following year:  it eliminates the double benefit.

“My child’s income must be claimed on my tax return” – Some minor children have savings accounts or trusts set up in their name.  If the account earns above a minimal amount of interest or dividends, the bank or investment firm will issue a Form 1099 to report the income.  This income DOES NOT need to be reported on the parents’ return, and would instead be put on the child’s return only if he/she is required to file (if not, then the income is not taxable).  Under some circumstances there is an option to report a child’s income on the parents’ return, and this exists to make filing easier (and also for the IRS to collect taxes on income that may not be taxable).  So if you and your child both have an account with the same bank or investment firm, be sure to check the social security number on the Form 1099; if it shows your child’s number, that income may not need to be reported at all.

“How much am I allowed to claim in charitable donations?” – I am asked this question all the time, and in most cases the answer is “You can claim whatever you donated if you itemize.”  There is a limit to the deduction but a person would have to be extremely generous for it to be a factor, and that limit is 60% of your income.  But even in the case of a person donating more than 60% of his income, he would be allowed to carry over the excess to future tax returns until it is used up (up to five years).  In some cases donations can only be deducted up to a limit of 20% or 30% of income, but in most cases only the 60% limit applies.  All in all though, if you donated less than 20% of your income to charity, you can deduct whatever you gave.  Again, as I mentioned before and up above in a previous myth, you must itemize deductions to claim any of your donations.