Tax-preparation season is underway. As you prepare your 2021 return and various forms and schedules, be sure to avoid buying into common tax myths that can cost you big money.
Tax myths typically have their roots in wishful thinking. But, basically, mistaking a tax myth for reality can lead to errors in income that you report and deductions that you take. And those lapses can cost you real-world money in the form of taxes, penalties and interest.
Tax Preparation: Dodge These Myths
To help you avoid committing such errors, here are 10 tax myths that leading financial advisors warn taxpayers to dodge.
Tax-Preparation Myth: Filing a tax extension means you can pay your tax bill later.
Reality: "Getting an extension allows you to file your tax return at a later date," said Will Vaughan, a wealth advisor at advisory firm RegentAtlantic. "However, you still must pay your outstanding tax bill by the original filing deadline to avoid penalties and interest."
Tax-Preparation Myth: Capital gains from investments can push you into a higher tax bracket.
Reality: Long-term capital gains and qualified dividends are taxed separately from your ordinary income, Vaughan says. "This means that while long-term capital gains might increase your tax bill, they'll never push you into a higher ordinary income tax bracket," he said.
Tax-Preparation Myth: Dividend and interest income of less than $10 does not have to be reported.
Reality: Interest and dividends less than $10 are typically not reported on 1099-DIV or 1099-INT tax forms. Still, taxpayers must report and pay tax on these amounts, including amounts less than $10 when filing federal taxes, says Nilay Gandhi, senior financial advisor at Vanguard Personal Advisor Services.
Are Your Social Security Benefits Taxable?
Tax-Preparation Myth: Social Security benefits are not subject to tax.
Reality: Benefits can be taxable. Whether taxpayers are subject to tax on their Social Security benefits is based on their overall income, including income from other sources such as a job and pension, Gandhi says. It also depends on their filing status.
Tax-Preparation Myth: If you don't receive a Form 1099 or other tax forms for certain income, you don't need to report that income.
Reality: "Extremely wrong," said Hayden Adams, director of tax and financial planning for the Schwab Center for Financial Research. "Even if you don't receive a Form 1099 or other tax forms, you still must report all income you received to the IRS. This includes all cash payments, rental income, side hustle income or any other form of payments, including bartering income."
Is Cryptocurrency Taxable?
Tax-Preparation Myth: Cryptocurrency is not taxable.
Reality: "Cryptocurrency is taxed the same as other investments," Adams said. "It's also subject to capital gains taxes just like any other asset. If you sell crypto asset for a gain, it can be taxed at the short-term or long-term capital gain tax rates, depending on your holding period. In addition, if you use crypto to purchase something like a car or TV, that transaction is seen by the IRS as a cryptocurrency sale. As a result, you could have a taxable gain to report on your tax return."
Tax-Preparation Myth: Filing an amended return is likely to trigger an audit.
Reality: "Untrue," said Schwab's Adams. "Generally, filing an amended return does not increase the odds of being audited by the IRS. If you deserve a refund, you definitely want to file an amended return to get the money owed to you."
Tax-Preparation Myth: Money made in foreign countries, such as from a business, is not taxable in the U.S.
Reality: "Not right," Adams said. You must report all income from whatever sources on your U.S. tax return. "There are tax deductions and credits available for foreign taxes you pay. But you must still report that income on your tax return."
Gift And Estate Tax Myths
Tax-Preparation Myth: The recipient of a large gift must pay tax on the amount received.
Reality: Gift tax, if any is due, is paid by the giver, not the recipient, says RegentAtlantic's Vaughan. The giver must file a gift tax return (Form 709) if the gift in 2021 is larger than the annual exclusion amount of $15,000. The 2022 exclusion is $16,000. Still, when does a single-filer giver actually need to pay gift tax? If their cumulative gifts during life and from their estate after death in 2021 totaled more than $11.7 million. If they die in 2022, the threshold is $12.06 million.
Tax-Preparation Myth: Your college-age child has unlimited leeway in declaring themselves the dependent of the parent with lower income and assets. That choice can improve their odds of winning college federal financial aid.
Reality: No, rules concerning dependent status on aid applications can differ from rules for dependent status on a tax return, says Roger Young, a Thought Leadership Director for T. Rowe Price. A dependent student with married parents has to report financial information for both parents on an aid application, even if they file taxes separately. If parents are divorced? The student reports financial information for the parent he lived with during the year or who provided more financial support.
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