The driver of tomorrow is not thinking Green...

The driver of tomorrow is not thinking Green...
He's thinking Classic. (click on photo)


Feb 2, 2010

5 tax myths that can cost you money

By Jeff Schnepper
MSN Money

Santa Claus. The tooth fairy. Babe Ruth pointing to where he would hit a home run in the 1932 World Series. Someone who knocks on your door, smiles and announces, "I'm from the government, and I'm here to help you."

Our culture is full of myths. And our tax system is full of myths, half-truths and untruths that can cost you big bucks if you don't understand the rules.

So let's have a look at some of the bigger myths about taxes. If I've done my job properly, I'll show you how they can trap you and how you can save money by separating myth from reality. And if you find you need more help, check this site for more information, or consult a tax professional.

Myth 1: Students are exempt

Lots of people believe there's an exemption for students that excludes them from tax. Wrong, scholarship breath!

There's no special tax status afforded to students. They are subject to tax on all 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 Lifetime Learning Credit and the new American Opportunity Credit, which has replaced the Hope Credit for 2009 and 2010. In addition, distributions from a Section 529 Plan are tax-free. But their income is subject to tax, just like everyone else's.

Many students who work over the summer check the box "exempt" on their W-4's. If they had no taxable income last year and don't expect to have any this year, that's OK. But let's say a student earned more than $5,450 in 2008 or $5,700 in 2009. And let's say she is claimed as a dependent on her parents' return. She will owe tax and penalties if she owes more than $1,000 or actually fails to file. Don't get caught in this trap.

Myth 2: My child is working, so I can't claim him as my dependent

Again, pure myth. As long as you provide more than half 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's spent, not what's earned. So, let's say your child makes millions as a teenage fashion model. If she banks all the cash and you actually shell out the dough to support her profession, you've provided 100% of that child's support.

Video: The most common tax mistakes

You can also qualify for a personal exemption for that child if the child doesn't earn more than the value of that exemption -- $3,650 for 2009. This income test doesn't apply to whether the child qualifies as your dependent, nor does it apply if the child is under age 19 or is a full-time student under age 24.

A child qualifies as a full-time student if, during each of any five months of the calendar year, he or she (a) is in full-time attendance at an educational institution or (b) is taking a full-time course of instructional or farm training.

Continued: Selling homes tax-free

Myth 3: I'm over age 55, so I can sell my house tax-free

Wrong again, graybeard! You're 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 in gain 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 taxes

This is a funny one. You haven't been able to deduct any sales taxes for purchases made for personal use since 1986.

But the deduction has made a comeback of sorts. Starting in 2004 and renewed through 2009, you can deduct your sales taxes from your federal income taxes 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 this year. It probably will be renewed, but that action could get hung up in political fights.

Now, what about sales taxes 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 itself 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 always file "Married Filing Separately." That normally results in you having to pay more in taxes. But in some 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. That is, 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, the first $7,500 in 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 $2,000, less the sum of $750 and $200) in additional deductions could offset the bracket and other limitations of filing separately.

Video: The most common tax mistakes

Try it both ways, and see which gives you the lower total tax. You can change your filing status annually.

I should add a caveat on this filing myth. If you're married, you normally can't file as single or head of household. Let's say, though, that you're married but separated, and you have a child. There's a special rule that will let you file as a head of household.

You can qualify as an "abandoned spouse" if your spouse didn't live with you for the last six months of the year and you have a child living with you who qualifies as your dependent. If so, you can file as head of household rather than jointly or married filing separately.

Run the numbers and see which produces the lowest tax bill.

Our tax code is complicated and changes with painful regularity. Many of the old rules are poorly remembered and distorted into myths. Don't get caught in the trap of using the wrong rules. That can cost you big!

Updated Dec. 3, 2009

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