Let’s Clarify Some Common Income Tax Misconceptions
Below is a list of common tax misconceptions among taxpayers. Perhaps this may help clarify some tax misconceptions for you:
“My uncle has a foreign bank account and I’m also a signer on it – but he owns the account. I don’t have to disclose this information on my tax return since I don’t own the account.” Full disclosure of foreign accounts is an area that is under heavy scrutiny right now. There are several factors in determining disclosure of these accounts/assets. The penalties for failure to disclose are severe. Even though you are not an owner, since you have signature authority on the account, the foreign bank account must be disclosed.
“My broker sold some stock this year and reinvested the money in another stock – I never got any money, so it’s not taxable, right?” Stock sales (outside of retirement accounts) are required to be reported. Gain or loss on each individual stock transaction stands on its own. Sales of mutual funds also apply here.
“I don’t have to pay taxes on my Social Security benefits.” Unfortunately, Social Security benefits may be required to be included in income. The amount, if any, is based on the amount of all other income as required to be reported on the tax return. The maximum amount of Social Security benefits that may be included in income is 85 percent.
“I own an S Corporation and was told I can take dividends in lieu of wages and save myself payroll taxes”. In regard to monies paid to shareholders/employees of an S Corporation, reasonable compensation must be paid before any dividends or loan repayments are permitted. Failure to properly report wages could result in a reclassification of the dividends/loan repayments as wages and subject you to penalties.
“I am a student who only works part-time, so I don’t have to file a tax return.” In addition to age, tax filing requirements are reliant on filing status, dependency status, amount of income and whether it is earned (i.e. through employment or self-employment) or unearned (passive income such as investment income, interest and dividend income, etc). Student status is not a factor.
“My relative lives in one of my rentals but pays little if any rent. I can still treat it as a rental since I have so many expenses.” Renting to relatives at amounts below fair market rental value is subject to limitations in that expenses cannot exceed income. There may be other limitations as well. The Tax Court has suggested that for a family member, a fair rent may be up to 20 percent less than market rent.
My wife and I separated last year and lived apart for most of the year. I should be able to file Single now, correct?” Couples who are not legally divorced or separated as of the end of the year are precluded from filing Single.
Unfortunately, taxpayers who prepare their own returns or deal with unlicensed preparers (only Enrolled Agents, Certified Public Accountants and Attorneys are credentialed with the IRS) may fail to include important information simply because they overlook it, a document was never received, or more commonly, just from lack of knowledge of the tax laws.
Another taxpayer misconception is that tax preparers simply fill out forms and push a button. The real value of licensed professionals is that they keep up with countless tax laws and regulations and have the expertise to know how to apply these rules for the benefit of the taxpayer. A good preparer will provide you with a checklist that will help reveal missing documents or information so that a complete and accurate tax return is prepared.
It is important to note that no matter who prepares your taxes, you are the one who is legally responsible for what’s on your return—making it even more important to hire a licensed (credentialed) tax professional.
This brings us to one more misconception: that all return preparers are federally licensed. In fact, the only federally-licensed tax professionals are enrolled agents (EAs), who must pass a rigorous, three-part competency test and a background check. And in order to maintain the enrolled agent license, EAs must complete annual continuing education requirements in tax law and ethics.
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Tax Samaritan is a team of Enrolled Agents with over 25 years of experience focusing on US tax preparation and representation. We maintain this tax blog where all articles are written by Enrolled Agents. Our main objective is to educate US taxpayers on their tax responsibilities and the selection of a tax professional. Our articles are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid.
When looking for a tax professional, choose carefully. We recommend that you generally want to hire an Enrolled Agent, such as Tax Samaritan or other professional licensed to practice before the IRS, such as a CPA or attorney. If you are a US taxpayer overseas, we further recommend that you seek a professional who is experienced in expat tax preparation (most tax professionals have limited to no experience with expat taxes).
Randall Brody is an enrolled agent, licensed by the US Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation, fulfill continuing education credits and adhere to a stringent code of ethics.
Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.