Most people believe that IRS forms and publications are so confusing that they might as well be written in Greek. In reality, most of the publications are written in plain English but are just lengthy or extremely detailed. Businesses and individuals can avoid common tax myths and make informed decisions based on accurate and current information.
Myth 1: Individuals Should File an Extension if They Can’t Afford Taxes
Because taxes are generally an unpleasant subject, many business owners don’t think about taxes until the last minute. They often discover that they owe more than they anticipated (self-employed workers know that tax season is about paying taxes, not getting a refund) and wonder if there is a way to buy themselves more time. The good news is that there is a way to get a six-month extension; the bad news is that this extension applies only to the tax return, not the tax liability.
In other words, Form 4868 automatically gives taxpayers an additional six months to organize their records and complete their personal income tax return, but it does not affect the due date for any tax owed. As explained in the 1040 Instructions for 2019, “An automatic 6-month extension to file doesn’t extend the time to pay your tax. If you don’t pay your tax by the original due date of your return, you will owe interest on the unpaid tax and may owe penalties.”
Here’s the truth: Taxpayers who need more time to complete the federal income tax return should file Form 4868 and pay owed taxes before the return is normally due. Even though the amount of owed tax will only be an estimate, it should protect the taxpayer from penalties and interest.
Myth 2: The Home Office Deduction Automatically Leads to an Audit
Audits can drag on for years and years and probably scare even the most record-conscious business owner. However, this fear should not prevent taxpayers from taking a deduction for business use of their homes. The world is changing and COVID-19 has dramatically increased the number of people working from home. In fact, a recent survey by Stanford economist Nicholas Bloom found that 42 percent of the U.S. labor force is currently working from home. Working from home is becoming more mainstream, and taxpayers who qualify for this deduction should take advantage of it.
Here’s how the deduction works: Those who qualify for the home office deduction can deduct a portion of their utilities, repairs, maintenance, rent, and other home-related expenses. There are two ways to calculate the deduction, the simplified option where the size of your home office is multiplied by a certain rate ($5/square foot for 2019 with a maximum of 300 square feet) and the detailed option where Form 8829 is used to calculate the exact amount based off of actual home expenditures.
Not every home office qualifies. Business owners must use a portion of their home exclusively for business. Just because an accountant occasionally answers emails from her kitchen table doesn’t mean that she can designate her entire kitchen as a home office. The home office must also be the primary location of the business, where someone typically takes care of administrative tasks, schedules appointments, and stores business records. This requirement doesn’t prohibit people from meeting clients elsewhere; it just means that a home office literally needs to be home-based.
Myth 3: It Makes Sense to Increase Spending to Increase Tax Deductions
This is a myth based on a myth. Firstly, a deduction simply lowers the amount of taxable income whereas a credit lowers the tax liability directly. To put this in everyday terms: Would someone rather skip the tip on $20 worth of drinks or use a $20-off coupon? The first option might lower the overall bill by a few dollars, but directly subtracting $20 from the overall bill will make a bigger difference.
With this in mind, remember that even though many expenses can be deducted, it isn’t wise to make purchases just to qualify for certain deductions. Advertising, education, insurance, and even travel-related expenses can be deducted, but it doesn’t make sense to increase business expenses just to decrease business income. At the end of the day, money is still spent. It’s like the receipts that tell customers how much they saved and ignore the fact that could have stayed home and kept all of their money.
In summary, keep track of necessary business expenses so that they can be deducted. But don’t artificially increase spending in hopes of outwitting the system.
Ad Fontes: Consulting Accurate Sources
As the old adage goes, anything that sounds too good to be true probably is. No one likes to pay taxes and no one likes to read IRS publications. Going to the source and spending some time on the IRS website for a few focused minutes might be worth it in the end so that business decisions are based on accurate information and not common tax myths. Before making any decisions, consult a CPA, tax associate, or other professional resources to understand more about managing taxes.
