In the 10+ years that I’ve been in the tax industry, I’ve answered a lot of “I heard [insert random “tax myth” here], is this true?” type of questions. I always love hearing a new one, because it just goes to show how creative people can be. When you start hearing about tax rules through the grapevine or in a thread on Facebook, it’s important to discuss with a professional so that you get down to the bottom of it. Luckily, I am a professional.
Here are some common tax myths that you can stop stressing over now.
MYTH 1: THE HOME OFFICE DEDUCTION IS AN AUTOMATIC RED FLAG
Many people choose not to take a deduction for their legitimate home office expenses because they are afraid that it will automatically cause them to get audited. Firstly, the Tax Code allows for the home office deduction, so the presence of the deduction alone will not cause the IRS to come looking for you. Secondly, if everything is true and correct to the best of your knowledge, there’s nothing to be afraid of. According to Upwork, nearly 50% of millennial workers are freelancing and working from home. According to the Direct Selling Association, 18.6 million people were involved in direct selling in 2017. That’s a lot of people leaving money on the table!
Some reasons that a home office deduction may raise some eyebrows is if it’s a large deduction compared to income, or if you are claiming a significant portion of your home as a home office. However, taking the deduction in and of itself is not an issue.
MYTH 2: STARTING A HOME BASED BUSINESS WILL SAVE ME MONEY ON TAXES
I’ve already discussed in detail why this is a myth, but it’s worth repeating. The highlights: All income-producing activities are not businesses. A business must have a profit motive. In order to save money on your taxes, you have to lose money. Starting a business to lose money is the very opposite of a profit motive. This may work in the long run, but is not a long term tax saving strategy.
MYTH 3: PUTTING A SIGN ON MY VEHICLE MEANS ALL OF MY MILES ARE BUSINESS RELATED
There’s this common misconception that slapping a decal on a vehicle automatically makes it 100% business use because you’re “always advertising”. No ma’am. Your miles are only considered business miles if the reason for the trip is primarily for business, which means that more than 50% of the reason for making the trip is business related. Listen, you can have a fully wrapped car that shouts your business name when you press the horn, but if there’s no business reason for that trip to Target those miles are not deductible, sis.
But you can deduct the cost of the sign as advertising.
MYTH 4: I CAN DEDUCT THE COST OF INVENTORY THAT I USE FOR MYSELF AS ADVERTISING
This one that I see all the time in direct sales. The idea is that if you sell nail polish and use your nail polish on yourself, you’re advertising for your business so therefore it can be deducted as an advertising expense. This is not true. Any inventory that you withdraw from your business is considered a personal expense. You’ll need to reduce your inventory for the items that you pull out for yourself or your family. These items also cannot be considered giveaway items.
MYTH 5: I DON’T HAVE TO REPORT INCOME THAT ISN’T REPORTED TO THE IRS
This is a common misconception because of the reporting requirements for payers to file information returns with the IRS. If you earned less than $600 with some customers, the payer is not required to send you or the IRS a Form 1099-MISC, but you are still required to report this income on your tax return. If you’re required to file a tax return, you’re required to report all of your income even if the information is not reported to the IRS. You should be keeping track of your income separately, so that you don’t have to rely on 1099s in order to properly report your income.
MYTH 6: AS LONG AS I HAVE A RECEIPT, I CAN WRITE IT OFF
I remember a client bringing me several tall kitchen trash bags full of receipts one year. I had to hire and pay someone to go through it all, and at the end of it, I couldn’t use most of it. There were receipts for grooming her dogs, expensive clothes, shoes, and bags, birthday trip travels, etc. All expenses that *could* potentially be deductible depending on the business, but were not deductible for her. People will try to write off their entire life on their business return, even for expenses that have zero to do with their business.
Deductible expenses have to be ordinary and necessary for your business. Ordinary means that the expense is common and accepted in your trade or business. Necessary means that the expense is helpful and appropriate for your trade or business. The IRS likes to play word games with us, so note that the necessary doesn’t mean required.
At the end of the day: if it’s not a legitimate business expense, no amount of receipts or paperwork or character letters from your high school principal will make it deductible.
MYTH 7: I DON’T HAVE TO REPORT EXPENSES ON MY SCHEDULE C IF THEY LOWER MY REFUND
It seems counterintuitive that increasing your expenses would lower your refund, but depending on your income level and whether you have children, it’s very possible. The Earned Income Credit and Additional Child Tax Credit are based on earned income. The Earned Income Credit is based on a bell curve, so the higher your income, the more credit you get to an extent. After that, the credit decreases with additional income. The Additional Child Tax Credit is limited to a certain percentage of your earned income over a certain threshold. Reducing your earned income could potentially reduce both of these credits, so it could be tempting to start removing expenses to find the “perfect” amount of earned income to claim both credits. Because of this potential to manage credits in this manner, the IRS requires that all of your allowable expenses be reported on your Schedule C. You don’t have the option of cherry picking your deductions to report the most beneficial earned income.
MYTH 8: TALKING ABOUT MY BUSINESS A LITTLE AT DINNER MAKES THE MEAL DEDUCTIBLE
Years ago I was out to dinner with friends and family, and one of the women at the table owned a business. She mentioned that she had a business, and then at the end of the meal she collected everybody’s receipts and said she was going to write them all off on her business return. Not only were other people’s meals not deductible on her return (because she didn’t pay for them, that’s called fraud… let’s be real), even her own meal was not deductible on her return. The IRS requires that in order to meals to be deductible they have to be directly related to or associated with your business. This means that the main purpose of the meal was the conduct of business. The meal must have a clear business purpose such as getting new business, or encouraging an existing business relationship and you must discuss a substantial amount of business before, during, or after the meal. Just mentioning your business at a family dinner doesn’t make the cut.
MYTH 9: I CAN WRITE OFF ALL OF THE CLOTHES I WEAR FOR BBUSINESS
Even if you buy certain clothes specifically to wear for work, you cannot deduct the cost of purchasing or cleaning them unless they are unsuitable for streetwear. So, before you go crazy buying all of those expensive suits to meet customers and clients in, just know that you cannot deduct that price tag on your tax return.
MYTH 10: I CAN TAKE A DEDUCTION OF $12K FOR EACH OF MY CHILDREN AGAINST MY BUSINESS INCOME
This one is tricky, as myths that have a grain of truth of them tend to be. While it’s not entirely incorrect, the information that floats around related to this is often incomplete. In order to take a deduction for money paid to your child, they have to be an actual employee of your company. They have to actually work, they have to be treated the same as any other employees, and they have to be paid in line with what they’re doing. In other words, you can’t hire your daughter to sharpen pencils for an hour on December 31 and pay her $12,000 because it’s unreasonable for a pencil sharpener to be paid $12,000 an hour. Basically, you can’t just say that you paid your child and write it off.
YOUR TAX RETURN
The easiest way to not stress yourself out or confuse yourself with all of the misinformation floating around is to stay in touch with your tax professional throughout the year (since y’all are besties now, anyway) and clear up any questionable “advice” by consulting with her regularly.
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