Tax-Related Urban Legends

Tax-Related Urban Legends

If there's one thing I've learned over the years, it's that there is a lot of bad advice floating around out there.  There's no shortage of myths, legends, rules of thumb and outright falsehoods.  Usually this bad advice comes from clients' friends and acquaintances.  Unfortunately, some of it comes from folks claiming to be tax professionals.  Let's dive into a few of them, in no particular order...

1. Signage on your vehicle makes it 100% deductible. The actual business use of the vehicle will determine its deductibility.  You can't just stick a logo on the door of your truck and ignore the personal use of it while driving your kids to soccer practice.  It also does not eliminate the need to keep good milage records.  The Mary Kay pink Cadillac isn't some sort of tax audit cloak of invisibility.  All the same rules apply.

2. You can avoid audits by staying away from "red flags".  How easy would it be if there was some published list of items which, if avoided, would guarantee that we'd never be audited?  Here's the sad truth....We live in a world where random audits exist.  In other words, your return may have nothing out of the ordinary, and still be pulled for a random audit.  This is the reason that my advice is always to approach every return you file with the expectation of being audited.  If you're prepared, you should have no concerns if you are asked to provide documentation for deduction items later.  Sometimes very real deduction items are outside the norm.  For example, if you do a lot of driving for your work, expect that it will be looked at from time to time and keep good records.  If you really do take clients out to lavish dinners for business three times a week, keep not just receipts, but also a log of who you met with and why.

3. Extensions raise your audit risk.  If you think about this from the IRS's point of view, it makes a lot of sense.  They don't want everyone's return in a compressed time period each year.  Thus, they make it easy and actually encourage us to spread their work out a bit.  A return filed in January is no more compliant than one filed October 15th five minutes before the post office closed.

4. Students do not pay taxes.  While this might be true for most students, it's because of low income, not because of some blanket exemption.

5. You can file as head of household and claim the kids while your spouse files single.  This one is so common that I'm really surprised it's not an enforcement priority for the IRS.  The head of household filing status is for single people with dependents.  It is possible in a narrow set of circumstances to legally qualify if you're married, for example if you are in the process of divorcing or if you live separately and just never legally divorced.  Head of household is just not an option for a married couple living in the same home with all of their kids.

6. If you don't take a depreciation deduction for property, you won't have to reclaim it when you sell.  This usually comes into play with rental property.  Many times, we see clients selling property they have had for years on which they never took a deduction for depreciation because they knew it would be recaptured when they sell.  Regulations require you to recapture depreciation "allowed or allowable".  What that means is that you must recapture it even if you never took the deduction while you were renting or using the property in a business.  So, take the deduction while you can.  You aren't doing yourself any favors by forgoing perfectly legitimate deductions.

7. You will owe tax for a gift received. The recipient of a gift never owes tax on it.  The only time this is not true is when otherwise taxable income is disguised as a gift.  Your employer can't give you a significant gift instead of paying your salary.  This situation comes up most often with "sweetheart deals" for employees.  For example, if your employer sells you an asset worth $20,000 for $5,000, then you have taxable income of $15,000 because it's really compensation for work.  The point is that it's not a true gift.

8. You will owe tax on an inheritance.  Inherited property may give rise to taxable income, but the inheritance itself is not taxable.  For example, if you inherit stocks, the dividends they pay are taxable, but the value of the stock itself is not taxable.  In almost all circumstance, you get what's called a "stepped up basis" in the property.  So, it doesn't matter that your grandmother paid pennies for the stock back when the Earth was still cooling and the sun only came up on Wednesdays.  You get it at what it's worth when you inherit it.  If you sell it immediately, you have no gain.  (You do have to report it, though.)  If you wait ten years to sell it, you only have a gain for the increase while it was in your hands.

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There are lots of examples like this in circulation.  Maybe we will revisit this again with another list.