Top Tax Myths Debunked
Learn the top tax myths and misconceptions. Know the facts at FindLaw.
The annual arrival of the 1040 Booklet in the mail marks the beginning of another new tax season. In keeping with this special time, FindLaw.com has set out to debunk some common myths regarding the filing of tax returns. Keep these truths in mind as you prepare your "love letter" (aka tax return) to the IRS.
Myth #1: Federal Income Taxes are Illegal, Invalid and/or Voluntary
"Filing a tax return violates my Fifth Amendment right against self-incrimination!"
Wrong. There are many different theories under which tax protestors claim that the payment of taxes and the filing of tax returns are voluntary and/or illegal. Some arguments are constitutionally based, while others hinge upon semantics and word play. For example, one flawed argument states that the 16th Amendment, which authorizes collection of income taxes, was not properly enacted. Another debunked contention claims that only residents of "sovereign" states, such as Washington D.C. and Puerto Rico, are required to pay income taxes.
The truth is that U.S. courts have universally found these tax avoidance arguments to be frivolous. Furthermore, the people who make these arguments usually end up liable for taxes and are sometimes hit with additional tax penalties.
The following quote from a federal appeals court sums up the flawed position of the tax protestor: "Like moths to a flame, some people find themselves irresistibly drawn to the tax protester movement's illusory claim that there is no legal requirement to pay federal income tax. And, like moths, these people sometimes get burned." -- US v. Sloan (7th Cir. 1991)
Myth #2: The Home Office Write-Off Myth
"I have a computer and a desk in my home, therefore I can take a home office deduction."
Not necessarily. One commonly misunderstood tax write-off is the home office deduction. Many believe that they can simply deduct the cost of their home computers by claiming a home office. However, just because you have a desk and a computer in your home does not mean you qualify for the home office deduction. In fact, the IRS has very specific guidelines for the home office exemption.
To qualify for this deduction, you need to be self-employed. According to the IRS, "You can claim this deduction for the business use of a part of your home only if you use that part of your home regularly and exclusively:
- As your principal place of business for any trade or business; or
- As a place to meet or deal with your patients, clients or customers in the normal course of your trade or business.
According to some tax professionals, this deduction is so frequently misused that the IRS views taking the home office deduction as one factor that may contribute to receiving an audit.
Myth #3: It's Easy To Write Off Your Gambling Losses
"I just lost a bundle in Vegas, but it's OK - I'm writing off the loss!"
Don't count on it. When it comes to writing off gambling losses on your income tax return, the IRS is very strict. Every year the IRS receives tax returns from people who claim their gambling income is minimal while their gambling losses are huge.
The IRS has a simple rule for gambling losses: Taxpayers can only claim deduction on losses equal to or less than their winnings. For example, in 2007 you win $500 gambling, but you lose $1,000 in gambling in the same year. Under the rule, you can only claim up to $500 (the amount of your winnings) in losses on your 2007 tax return.
One highlight is that the IRS is not particular about how you lost your money, as long as it was by gambling. So, it doesn't matter if you lost at the track, the craps table, or the roulette wheel. If you won $500 in the lottery, you can claim any $500 that you lost in fantasy football or at the casino.
A word of caution: Gambling income and losses are among the favorite red flags that the IRS looks for when ordering an audit. If you do write off your gambling losses, be sure that you have all your paperwork to back up your claims.
Myth #4: Restaurant Tips Don't Count As Taxable Income
"There's no record of my tips, so I don't have to report them as income."
Here's a real tip. Workers who receive tips often believe that their tips are not taxable income. The IRS, however, does view tips as taxable income.
Most tips are given in cash directly to an employee, and there are often no formal records of the tip amount. Recognizing the lack of precise records, the IRS has created tip reporting responsibilities for workers who receive them. These tip reporting obligations apply to workers in restaurants, hotels, taxicabs, and other personal services.
If in any month you earn more than $20 in tips, federal tax laws require you to report that amount to your employer by the 10th of the following month. This includes tips you receive directly from the customer, as well as amounts you receive from "tip-outs" or tip pooling arrangements.
Restaurant workers and employers, in particular, have heightened tip reporting obligations to the government. Tipping is so commonplace in eating establishments that the IRS has established the voluntary Tip Reporting Alternative Commitment (TRAC) program, under which restaurants agree to create tip reporting systems and educate employees about their reporting responsibilities.
Myth #5: There Are No Benefits to e-Filing
"I don't trust computers and there are no good reasons to e-file my tax return."
Easy does it, technophobe. Many taxpayers mistakenly believe that there are no good reasons to e-file their tax returns. This myth may be based on mistrust of technology or any of the downsides to e-filing. In actuality, however, there are numerous benefits to e-filing your tax return.
First, if you e-file you stand to receive your tax refund sooner than if you paper file. The IRS usually sends out refund checks within three weeks of receipt, and direct deposit payments are made even faster.
E-filing your tax return also provides greater accuracy than filing a paper tax return. According to government statistics, electronically filed tax returns have fewer taxpayer and IRS processing errors than paper returns. 80 million people filed their taxes electronically in 2007, so you can rest assured that the e-filing systems work.
When you e-file, your tax return will never be "lost in the mail". And there will be no more standing in long lines at the post office when you e-file.
To be sure, there are certain costs and drawbacks associated with e-filing. In order to electronically file you tax return, you have to purchase your own e-filing software or use an authorized e-filing service, unless you qualify for free e-filing. E-filing is free if you make $56,000 or less a year. If your income tax return is overly complex, some e-filing solutions may not be recommended. Finally, if you are not comfortable using a computer, e-filing may not be right for you.
IRS e-file for Individual Taxpayers: File Taxes Online
For a complete list of tax misconceptions, read the IRS publication, Truth About Frivolous Tax Arguments.