5 Tax Myths That Can Cost You Money
We all think we know the parts of the tax law that affect us. But do we really? If you believe some of these myths, you could pay more tax than you should.
Myth 1: “Students are exempt”
Lots of people believe there is an exemption for students that exclude them from tax. Wrong!
There is no special tax status afforded to students. They are subject to tax on all of their income, regardless of how many credits they’re taking or whether or not they’re fully matriculated.
Students do get special tax credits, the Hope Credit and the Lifetime Learning Credit. But if the student is taken as an exemption on their parents’ tax return, then these credits would be available to the parents of the student. In addition, distributions from Section 529 plan are now tax-free. But their income is subject to tax, just like the rest of us.
Many a student who works over the summer checks the box “exempt” on their W-4 form. If he or she had no taxable income last year and doesn’t expect to have any this year, that’s okay. But let’s say he or she earned more than $5,700 in 2009 and 2010. In addition, he or she is claimed as a dependent on their parents’ tax return. The student will owe tax and penalties if he or she owes more than $1,000 in tax and actually fails to file. Don’t get caught in this trap.
Myth 2: “My child is working, so I can’t claim he or she as my dependent”
Again, this is pure myth. As long as you provide more than half of that child’s support (and meet other qualifications such as citizenship and relationship), the child qualifies as your dependent, and you can deduct, for example, all the medical costs you paid for that child.
Remember, support is what is spent, not what is earned. So, let’s say your child makes millions as a teenage fashion model. If she banks all of the cash and you actually shell out the dough to support her profession, you provided 100% of that child’s support.
Myth 3: “I’m over age 55, so I can sell my house tax-free”
Wrong again. You are thinking old law.
It used to be that if you were older than 55, you could exclude as much as $125,000 in gains from taxes, but only once. Now the rules are even better.
Under current law, age no longer matters. If the property sold was your principal residence for at least two out of the last five years, you can exclude from tax as much as $250,000 in gain (and $500,000 on a joint return).
Your age is irrelevant, and you can take the gain exclusion every two years, if you qualify. By the same token, if your property appreciates by $250,000 to $500,000 every two years, give me a call. I could use your help in finding a new house!!
Myth 4: “I can deduct my sales tax”
This is a funny one! You haven’t been able to deduct any sales tax for purchases made for personal use since 1986.
But the deduction has made a comeback of sorts. Starting in 2004 and renewed for returns filed in 2006 through 2009, one can deduct your sales tax on your tax return or your state income taxes, but not both. If you live in one of seven states – Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming – you just got a nice deduction. You don’t pay income taxes in those states.
Don’t get too chummy with this break if you live in one of those states, though. Congress will be asked to renew it before the end of 2010. It probably will happen, but it could get hung up in political fights.
Now what about sales tax paid on purchases made in the course of business? Easy. If you pay sales tax on an item bought for business and if the item would be allowed as a business deduction, then the sales tax on that item would be allowed as well, no matter what.
Myth 5: “I’m married, so I have to file a joint return”
Again, not true. If you’re married, you can file “Married, Filing Separately”. That normally results in your paying more in taxes. But in some isolated situations, it can be to your advantage.
For example, if one spouse has substantial medical or miscellaneous deductions, those deductions are subject to the 7.5% and 2% floors, respectively. This means that only medical expenses over 7.5% of adjusted gross income and miscellaneous deductions over 2% of adjusted gross income are deductible. If I had $10,000 in income and my spouse had $90,000 in income (which is a total of $100,000 between the two of us), the first $7,500 of medical expenses and the first $2,000 in miscellaneous expenses aren’t allowed.
But if I filed as “Married, Filing Separately”, the disallowance would only apply to the first $750 in medical expenses and the first $200 in miscellaneous itemized expenses. The potential availability of $8,550 ($7,500 plus the $2,000, less the sum of $750 and $200) in additional deductions could offset the bracket and other limitations of filing separately.
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