I came across an article the other day related to the most common taxpayer misconceptions about the tax law and many of them sounded familiar to me as I had seen or heard similar statements during my career in tax consulting and preparation. I want to share a few of these in this month’s blog in an effort to possibly clear up any confusion that may exist.
One misconception is that social security benefits are not taxable income to the recipient. Although this statement may be true for certain taxpayers, it definitely is not true for many more. The determining factor of whether your social security benefits are taxable is your overall income level and filing status. A quick way to find out if any of your benefits are taxable is to add one half of your social security benefits for the year to all your other income. If the total is over $25,000 and your filing status is single or head of household, then some of your benefits may be taxable. If the total is over $32,000 and your filing status is married filing joint, some of your benefits may be taxable. If your filing status is married filing separate and you lived with your spouse at any time during the year, there is no minimum income threshold and a portion of your benefits will be taxable. The maximum portion of your social security benefits that may be taxed is 85%.
Another misconception is that if you use the proceeds from a securities sale to purchase other securities, that the sale of the original securities is not taxable income to you. Outside of a section 1035 exchange (usually applicable to annuity contracts), all securities sales outside of qualified retirement accounts must be reported on your tax return. Your adjusted cost basis in the securities as well as the length of time you held the security will determine whether you have a gain or loss and whether that gain or loss is short-term or long-term in nature. Any securities held one year or less are short-term and are subject to generally higher ordinary income tax rates. Any securities held for longer than one year are long-term and are afforded lower long-term capital gain tax treatment.
Some taxpayers believe that if they are a full-time student only working part-time that they are not required to file an income tax return. In reality, tax return filing requirements are based on filing status, dependency status, income level and whether the income is earned or unearned and not on whether you are a student.
Some rental property owners believe that they can fully deduct the losses from rental activity involved related parties such as family members. Although the IRS will often allow related parties to rent property to each other for up to 20% below market rates, there are special limits imposed on how the rental activity is reported for tax purposes. Specifically, the owner of the property can’t generally claim a loss (expenses exceed revenue) for a property leased to a related party.
Married taxpayers who have separated during the year may think that they are eligible to file with single status for that year, but that is not generally the case. Unless the taxpayer was legally divorced or legally separated by the last day of the year, the only filing options they can choose are married filing joint or married filing separate. As in the case of a new marriage, the married status as of the end of the day on December 31st determines whether you are deemed to be married or not for the entire year for tax purposes.
Some taxpayers may believe that once a certain age is attained, the requirement to file an income tax return goes away. In reality, age has no bearing on whether a taxpayer must file an income tax return. Filing status, income level and other factors determine whether a tax return is required each year.
Other taxpayers may believe that they are entitled to deduct the cost of clothing related to their work. The fact of the matter is that only in certain occupations or with certain work-related uniforms are work clothing costs a deductible expense. A general rule of thumb is that if you can wear the clothing generally for other non-work-related activities, it is not a tax deductible expense.
If you have any questions related to tax law, please contact us.