The 3 Most Common Tax Myths

Our Federal tax code is complicated. One thing this causes is misunderstandings of tax law. I like to call these misunderstandings “tax myths.” Like many myths, tax myths often have some truth in them. Let’s look at three common tax myths.

1. I Don’t Want to Go Up to a New Tax Bracket

Sometimes people think that if they go up a Federal tax bracket, all of their income will be taxed at the higher rate. This is not true. Let’s look at the first two brackets for filing single in 2020. If your taxable income (after deductions) is $9,875 or less, your tax rate is 10% on this money. But if your taxable income goes up to $20,875, then you are squarely in the 12% tax bracket. That means that $9,875 is subject to the 10% tax rate. The extra $11,000 is subject to the 12% tax rate.

Also, tax credits can lower your effective tax rate, even down to zero. Higher income can cause your taxes to go up and can reduce some tax credits. But if you make more money, you will have more money!

2. Don’t Worry, I’ll Deduct It

This statement implies that your expense won’t actually cost you anything. That is rarely the case. If your marginal tax rate is 12%, then in most cases if you spend $100 that is deductible, you will only get $12 of it “back” through your tax return. And that is assuming it is really deductible.

In the gig economy, many of us have self-employed income. If you have self-employed or business income, you can deduct qualifying expenses. The key is the word “qualifying.” You should know if something is deductible or not before deducting it, or better yet before the spending. Also, if you aren’t self-employed and you aren’t in the position to itemize, meaning you take the standard deduction instead of adding up Schedule A deductions, then most likely you can’t deduct more than the new $300 charitable contribution above the line deduction ($600 for MFJ filers for tax year 2021 and beyond).

3. I’ll Buy a House to Reduce Taxes

Most realtors are great people. They help other people realize their dreams. But every year I sit down with clients who are excited about getting the tax benefit for the house they bought. And for most of those clients I have to tell them that the house isn’t going to help them with their taxes. Many say, “But my realtor said I would save on taxes!” That is true only if you are in the position to itemize on the Schedule A and if itemizing will get you higher than the standard deduction. You can either itemize or take the standard deduction. The most typical things people itemize on a Federal return are:

• Mortgage interest paid
• Real estate taxes
• State and local taxes
• Charitable contributions
• There are more, but they are less common

For filing head of household in 2020, those would have to add up to more than $18,650. It would be $24,800 for Married Filing Jointly. Most of us aren’t in the position to itemize that much. So most of us shouldn’t be buying a house to “save on taxes.”

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Please leave this article with this recommendation: if someone tells you something about taxes, make sure it is correct before making a decision based on that information. You need to figure out whether it’s relevant for you and your situation. If you have access to a tax professional, then consult them. If you don’t, IRS.gov has loads of information organized into tax topics and in their publications.