Rife with myth

People believe in some pretty incredible things when it comes time to pay federal taxes. (Don't be one of them.)

February 07, 2010|By Eileen Ambrose Personal finance

The tax code is huge and complicated - perfect fodder for myth-making.

Perhaps the most well-worn fallacy - shot down by many courts - is that federal taxes are illegal.

It's an argument often used by people who then have turned to Tax Masters, which helps filers in trouble with the IRS, says company President Patrick Cox. Some clients claimed they didn't owe U.S. taxes because they are "citizens of the world." If that were the case, maybe they should be paying taxes to the United Nations, Cox says jokingly.

Many myths involve audits. That's understandable, given that the IRS doesn't dish details on what triggers an audit. Some tax legends maintain that the IRS will give your return an extra look if you call the agency to ask a question.

"Not true," says IRS spokesman Jim Dupree. "If someone asks a general tax question, we aren't going to ask who they are."

To help separate fact from fiction, here are some common myths:

Income taxes are unconstitutional Pick an amendment - from the right to free speech to protections against self-incrimination and involuntary servitude - and tax protesters have used it to justify not paying taxes. In particular, the 97-year-old 16th Amendment, which authorized Congress to enact our current tax system, has long been under attack.

"There are some people in jail who argued that the 16th Amendment was never ratified," says Eddy Quijano, an instructor at California Polytechnic State University and a former IRS lawyer.

Actor Wesley Snipes, who argued that he wasn't legally required to pay taxes, may soon join other so-called tax deniers in jail. He was convicted of failing to file tax returns in 2008 and remains free while appealing his three-year prison sentence.

Similarly, some argue that because we have a "voluntary" system, taxes are optional. But voluntary only "means the government is trusting you to self-report how much tax you owe," says George Willis, an associate clinical professor at Chapman University School of Law.

Bartering is tax-free Bartering has blossomed in the recession, particularly online. But while no money changes hands, the value of the swaps is taxable income for both sides, Quijano says.

Internet revenue isn't taxable Online entrepreneurs who believe this are in for a rude shock next year, says Barbara Weltman, author of "J.K. Lasser's 1001 Deductions & Tax Breaks." That's when credit card companies and groups like PayPal must start reporting merchant sales to the IRS, she says.

Ill-gotten gains aren't taxable Even if your line of work is theft, embezzlement, prostitution, or some other illegal enterprise, that income is taxable.

Take bribing a senator. "The senator should report the bribe," Willis says. He quickly adds: "The bribe is not deductible to the payer."

Cash isn't taxed Tips, gambling winnings, extra bucks you earn under the table and money you find on the street must be reported to the IRS and is subject to tax.

"The law requires reporting all your income, even if it's not on a Form 1099 or W-2," says Zack Goff, a senior tax analyst with The Tax Institute at H&R Block.

The IRS has the tools to uncover unreported cash. "They can get access to bank account information and other third-party sources to, in a roundabout way, verify income," Goff says.

My dog is my dependent "The joke was, before the IRS required Social Security numbers [for dependents], people claimed their dogs and cats," Willis says.

The IRS definition of dependent is strict. Dependents typically are children or other relatives who get more than half their financial support from you. No pets.

Home-office deduction triggers audits This used to be true when anyone with a desk in the basement claimed it as a home office. Teachers were big offenders, saying they graded papers at home even though their principal place of business was the school, Weltman says. The rules were clarified in the 1990s, so people are less likely to mistakenly claim the deduction, and it's not the red flag to the IRS that it once was, she says.

Extensions lead to audits Filers suspect that if they request more time to file a return, the IRS will get suspicious and might pull them in. But extensions are routine and don't raise an eyebrow.

What prompts an audit "is a guarded secret," says Dennis Raible, an accounting professor at Saint Joseph's University and a former IRS agent. But red flags are raised when income listed on a return doesn't match what the employer reported or your claims seem way out of line with others in your locale, he says.

If you get a refund, you won't be audited A refund doesn't mean you're in the clear, Quijano says. The IRS generally can audit returns filed within the past three years, but there's no limit to its reach if fraud is involved.

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