4 Tax Myths Costing You Money
While I admire anyone who wants to learn more about taxes, there are a few common myths that continue to get the best of us. Misunderstandings about the tax code can cost your more at tax time or worse – open you up to IRS audits and notices. Read more to uncover common tax myths that could cost you at tax time.
1. Making my business an LLC saves money on my taxes. An “LLC”, short for “limited liability company” is a state level entity designation designed to limit the owner’s personal responsibility for the business’s debts and lawsuits. If the business is sued and loses, then the owner’s personal assets stay separate from the business. Creditors can only go after the company’s assets. However, when it comes to federal taxes, an LLC is considered a “pass-through entity” – the same as a sole proprietor. A business owned by a sole proprietor and an LLC will both have profits and losses calculated on Schedule C which carry over to the individual’s tax return to be taxed at the rate equal to the calculated tax for their modified adjusted gross income. In other words, whether you’re a sole proprietor or LLC, the profits (or losses) are added to your total earnings and taxed accordingly.
2. I want to put my house into an LLC so that I can deduct more on my taxes. Thanks to social media, a lot of average non-investors think they can put their house in a business name, cash in and get rich. First, the house usually has to be paid off. Most home lenders do not allow houses to be converted to the name of a business that was not on the original deed. Unless you purchased the home in the name of the business, the deed to the house cannot be transferred to an LLC. Aside from that, IRS rules still require that rental property income have “active participation” – meaning you spend more than 720 hours, actively being a real estate agent or broker. It’s a high bar. While there are lots of legitimate ways that homes can be purchased under an LLC and deducted on taxes, generally, this strategy is for active real estate investors only.
3. I don’t want to make more money because I’ll pay more than I make in taxes. While this may seem like an obvious myth, many people have heard this advice and implement it without giving it much thought. It implies that you should forgo a raise because the raise will qualify for a higher tax bracket, resulting in paying more taxes than the raise. This is mathematically false. Taxes are a percentage of a dollar. The average American pays about 15% effective tax rate. So in essence, you could be giving up $1 to avoid paying $0.15. . . Which makes no sense.
4. I can’t file jointly with my husband because they’ll take my tax refund. Imagine my surprise as a single person when I discovered that many people miss the advantages of married filing jointly because one spouse owes back taxes or is having their tax refunds garnished. Their tax preparer never informed them of injured spouse relief or their options to separate liability of taxes. The tax code favors married filing jointly. If you’re married and unable to file jointly and get your tax refund, your tax preparer should be able to assist.