Taxes are a fixed certainty in our lives. But they can be as confusing as a Christopher Nolan film (seriously, you gotta watch those a second time to figure out all the details. Like, is Leonardo DiCaprio in the real world or a dream at the end of Inception!?). Anyway, with today’s tax code being about 7,000 pages long, there are quite a few common tax myths that are always circulating.
So we figured it’s time to debunk the ones we hear most often because we don’t want you walking around with some janky stuff in your head about such an important subject.
Tax Myth #1: “If I file an extension, I don’t have to pay anything to the IRS until September”
This would be a nice way to hang onto your money for a few more months if you owe taxes, right!? Just tell the IRS to wait a few more months and keep that money in your bank account.
But sadly, this tax myth isn’t true. Even if you have filed an extension and are waiting to file your return until September, you’ll still have to determine what you owe the IRS and pay them now. If not, you’ll owe penalties in addition to that tax when you do pay this Fall.
Making sure that you don’t screw this up is important. You’ll owe 0.5% interest every single month that you are late in paying the IRS what you owe. Depending on the amount, this could be a huge penalty!
Tax Myth #2: “Tax refunds are great – free money!”
If you’re getting thousands of dollars back on your taxes, it feels so good, right!? But just think… you could have been using that money all year long to save more, pay off debt, invest in yourself, or put more money in tax-advantaged accounts to grow your wealth!
If you are owed a refund, some people say that you’ve given an interest-free loan to the government. And that makes some sense. But the real problem is that when you get money in the form of a tax refund it tends to feel like a windfall and you’re more apt to spend it recklessly. A lump-sum tax refund is more of an emotional & behavioral money conundrum than an “I just lost $8.20 in interest to the IRS this year” problem.
On the flip side of the coin, if you are savvy about using that tax refund in a smart way to immediately boost your savings or max out your Roth IRA, then getting a tax refund isn’t all that bad. Because, as we said, it’s not costing you all that much in actual return on your money.
Pro tip: Use the IRS tax withholding calculator so that you don’t go overboard in either direction. “Perfect” tax planning means getting exactly $0 in return when filing.
Tax Myth #3: “I should spend more, because I can write it off on my taxes”
We’ve heard a lot of small business owners say this throughout the years. Need a new laptop? Write it off! How about some new mics for the podcast? Let’s write it off! Reminds me of that scene from The Princess Bride…
It can be easy to fall into the trap of thinking that we can justify an expense, especially for a business, and that it’s not actually costing us anything. Unfortunately, that’s not how tax write offs work!
How tax write offs really work: When you ‘write something off’, you’re deducting that expense from your taxable income, and then you’re only taxed on what’s left. So for instance, let’s say you earned $50k and you had a tax-justifiable expense last year of $1k for a laptop. So you’re now only going to be paying taxes on the remaining $49k.
Now let’s say your tax rate was at 22%, well that means by deducting your taxable income by that $1k, you’re only saving $220, which is 22% of $1k.
Furthermore, in order to write something off you’ll need to itemize your deductions. And since an estimated 90% of Americans take the standard deduction, it’s quite likely that the $1k laptop you just bought doesn’t actually save you anything! Don’t fall into the writeoff trap assuming that spending more will massively cut your tax bill.
Tax Myth #4: “If I get a raise, I’ll actually LOSE money because I’ll be in a higher tax bracket”
One of the most common tax myths is folks assuming that their tax bracket = their tax rate. Not true! This is where marginal tax rates come into play.
Thankfully, we have a progressive tax system in the US. It taxes the first dollars you earn at a lower rate than the dollars earn later in the year. So for all of you folks worried about getting a raise, you will only pay the higher tax rate *on the dollar amount that is in the next bracket*, not your entire earnings.
Tax Myth #5: “If I can’t afford to pay, I don’t need to file my taxes at all.”
Another one of the most common tax myths that we’ve heard a lot over the years… Why file your taxes if you can’t pay the bill? It seems like a waste of time, right?
Well, you gotta file your taxes even if you can’t pay the tax you owe. If not, you’ll owe more in the end because the IRS can assess a failure to file penalty that can increase your tax bill even more. The fee is literally 5% per month that you are late – up to 25%!! Ouch.
So even if you can’t pay, file! Even if you can’t pay the full amount, pay what you can. There are a bunch of payment plans or installment options available also that the IRS offers.
Tax Myth #6: “Married people have to file jointly”
Nope, you sure don’t! You can choose to file separately as a married couple.
For most folks, choosing to file together is often the best move from a tax standpoint. Married filing separately, for instance, will disqualify you from getting the child tax credit which is a pretty big one if you have kids.
But in some cases, it does make more sense to file separately as a married couple. Let’s say one spouse has a lot of student loan debt and also has a lower salary… Filing separately could lower the necessary student loan payment and allow for more of that student loan debt to ultimately be forgiven. That being said, filing separately also means not being able to deduct the interest paid on those student loans. So you need to weigh the pros and cons.
Here’s a quick guide to pros and cons of filing separately vs. jointly.
Tax Myth #7: “I shouldn’t pay off debt because you can deduct the interest from my tax bill”
So you’re keeping toxic debt in your life just in order to get a tax break? 🤦♂️ Nooooooo!!!
People always overestimate the tax break that they get from a home mortgage or other interest deductions they are allowed. In fact, because most Americans take the standard deduction under today’s current tax rules (as we mentioned earlier), they aren’t getting any mortgage interest deduction!
Really, it only makes sense to keep good debt hanging around if you’re going to be incredibly proactive and intentional with that money. We’re talking about some of the different money gears. Things like creating an emergency fund, investing, or saving for some important goals or life events.
Tax Myth #8: “I don’t make enough money to get audited”
Or on the flip side, some people think “I should be really scared of getting audited!”… Well, neither of these are true.
First of all, the IRS can audit you if you make $10k or $10 million. So there’s no guarantee that they’ll ignore you just because you don’t make all that much. But before you start freaking out, it’s also worth noting that the IRS doesn’t audit that many returns. We’re talking about half a percent. Also, if you make less than $200k you have an even lower likelihood of being audited (although glaring errors could still make you a target).
To avoid being audited: Double and triple check your basic personal information and numbers. Most audits are triggered by fat-fingering.
The Bottom Line:
Hopefully, we were able to debunk a few of the most common tax myths and misconceptions in this article. If you are in real tax trouble or have unique questions, we’d recommend that you get professional help.
You can also reach out to the IRS taxpayer assistance or the taxpayer advocate if you have a bigger issue and aren’t sure how to proceed. But most of the things we mentioned today are in the “good to know so that you don’t make a minor goof and run afoul of the IRS” category.
Beer Tasting Notes From this Episode:
While talking about these common tax myths we enjoyed a Sponch-O Villa by J Wakefield! And please help us to spread the word by letting friends and family know about How to Money! Hit the share button, subscribe if you’re not already a regular listener. And give us a quick review in Apple Podcasts or wherever you get your podcasts. Help us to change the conversation around personal finance and get more people doing smart things with their money!
Best friends out!
Thanks for your podcast. Nice Info!!!
I want to let you know that the interest you pay on student loans can be deducted no matter if you take the standard deduction or the itemized deduction.
Hey Carl, thanks for listening!
And that’s right- student loans are considered an adjustment to income so you can still account for those while taking the standard deduction. If we said otherwise on the show it must’ve been a slip of the tongue!