The Truth Behind Five Tax Myths


From Yes, it's time once again to embark on the ambitious task of deciphering the U.S. tax code.

Many taxpayers are bound to get tripped up by the accepted wisdom that gets recycled every tax season.

So we've put together a list of common tax myths. Debunking the standard school of thought will often help you get the most out of this year's tax return.

Myth No. 1. You make too much/not enough to contribute to get tax advantages from a traditional IRA.

Wrong. As long as you're employed, you make just the right amount.

You may earn too much to deduct your contributions, says James J. Holtzman an adviser with Pittsburgh-based Legend Financial Advisors, but there's no income cap on contributing to traditional IRAs. And, no matter your income, all earnings on the account are tax deferred, which make IRAs an attractive investment vehicle.

But be aware, though you'll qualify for a traditional IRA, if your income is above six figures, you may not be eligible for a Roth IRA. And some people who are unemployed may be eligible to contribute if their spouse is employed.

Myth No. 2. If you're in the 20% tax bracket and you itemize, it's like the federal government pays a fifth of your deductible expenses.

As it turns out, Uncle Sam isn't nearly so generous.

You only get an added benefit for deductable expenses after your itemized expenses exceed the standard deduction--$5,380 for a single person without dependents.

So if you have $10,000 in deductable expenses, and are in a 20% tax bracket, you get back an extra $924 by itemizing: a discount of 9.24%.

It's nothing to sneeze at, but you're hardly getting a 20% discount. And if you're only able to itemize $6,000, you'd only get back an extra $132, an added 2.2%.

The more deductible expenses you have, of course, the larger the percentage discount.

Regardless, if your itemized deduction is greater than your automatic deduction, then, without a doubt, you should itemize.

But if you're changing your financial behavior to get a tax break -- buying a home, for instance -- keep in mind: if you were previously claiming a standard deduction, your marginal tax advantage may end up being relatively small.

Myth No. 3. You must itemize to get tax breaks.

Not so, says Jackie Perlman, lead tax researcher for the Tax Institute at H&R Block.

You can take some deductions -- known as "above the line" -- whether or not you itemize. If you move for a new job, for instance, you can generally deduct the expenses, Perlman says.

Likewise, tax credits don't require itemizing. If you're a working student, you may benefit from the Hope or Lifetime Learning credits. If you have kids, you may qualify for the earned income credit, child tax credit, or child-care credit.

Myth No. 4. Getting a huge return is a good thing.

In fact, you're acting like bank that would go belly up before long. That's because you've just given the government an interest-free loan, says Lauren Lindsay, a Baton Rouge, La.-based fee-only financial adviser.

You don't want to end up owing money at the end of the year, Lindsay says, but if your refund exceeds $500 to $1,500, you might want to find a good CPA to suggest changes for next year's return.

Myth No. 5. All tax preparers know more than about tax preparation than you.

Many do, of course.

But before you throw your hands up and leave your returns in the hands of a professional, be aware: The number of tax preparers who make mistakes is staggering.

According to a limited 2006 Government Accounting Office survey of chain preparers, each of the agency's 19 visits to tax preparers resulted in tax returns with mistakes, eight of them resulting in excess or deficit claims exceeding $1,000.

And the Better Business Bureau says that nearly a third of consumers who make complaints against tax preparers say that the preparers made mistakes on their returns.

There are obvious advantages to using a tax preparer. According to the GAO report, in 2002 taxpayers received an average of 65% more back using a paid tax preparer than by filing their own returns.

But one tax preparer isn't the same as another: Most states don't require any particular licensing for tax preparers. So anyone -- from a CPA or an attorney to a high-school dropout -- can legally prepare your taxes.

So take care when choosing a tax preparer, because no matter who does your taxes, you're responsible for extra taxes, fees and penalties from any mistakes.

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