Certified Public Accountants

Tax Myths

TAXING TIMES, November 2013 Edition

By Rick Torkelson, CPA and principal of Torkelson & Associates, LLP in Petaluma, CA

There’s a lot of tax information out there that gets repeated so often that pretty soon it becomes common knowledge – even though it isn’t true.  I’ve picked out a few of these “Tax Myths” to share and discuss.

“I don’t want to pay off my house because I need the interest deduction.”

There might be a few reasons why you might not want to pay off your house (assuming that you can), but losing the tax deduction shouldn’t be one of them.  If we assume you are a typical middle class taxpayer, your highest tax bracket could be 25% Federal and 8% California – say 33% total.  This means a $15,000 interest deduction on your house would be worth $5,000 in tax savings.  So how many 33 cent pieces would you like to buy for a dollar?

“My neighbor makes a lot more money than I and he doesn’t pay any taxes!”

I always ask the client to get a copy of your neighbor’s tax return and I’d explain it to them, but usually this misconception confuses “refund” with not owing taxes.  If you have a $10,000 tax liability and $15,000 withheld from your wages to pay tax, you have a $5,000 refund – but you paid $10,000.  If you have a $500 tax liability and nothing withheld from your wages, you owe $500.  So who pays more tax – the $5,000 refund or the $500 balance due?

“I inherited some money from my mother – how much tax do I have to pay?”

Typically – None.  There are exceptions if the decedent didn’t pay tax on the money such as with an IRA, but inheritance is tax free.  Even if you inherit $20 million, the decedent’s estate may have had an estate tax, but by the time the heir gets the money, no tax.  The same is true for gifts too.

“I can’t afford to sell the property because of the capital gains tax.”

Many people believe that capital gains are a big add-on tax due immediately when you sell the underlying property.  The fact is that capital gains are added to the rest of the income for the year on your tax return and due April 15 like everything else.  And – an alternative computation is made on the capital gain which results in a lower tax than the tax on almost every other type of income.  Capital gains are good – at least compared to other taxable income.

“I got a bonus and I’m afraid it’s going to put me in a higher tax bracket.”

Take all the bonuses you can get – You can’t make that ill-fated dollar and owe all kinds of tax as a result.  Tax rates are graduated.  At first our income is not taxed at all as you earn up to your deductions and dependent exemptions.  The next dollar is taxed at 10% – but only that dollar.  The same is true along the way as you use up the 10%, 15%, and so on.  If you’re bonus is big enough, the maximum it can be taxed is 39.6% if you’re single and have taxable earnings over $400,000 (or $450,000 if married).

FINAL COMMENTS

Don’t believe everything you hear on the streets just because you’ve heard it a lot.  As always, if it sounds too good (or bad) to be true, it probably is.

REMINDERS

This is a good time for tax planning – before the end of the year – while there’s time to do something about it.

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