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Debunking common myths and misunderstandings about taxes


Tax day is around the corner. Perhaps like us, you have some questions about what you owe or where to go for help. So we reached out to Andy Rosen. He writes about taxes and investing for NerdWallet, a personal finance site. We asked him about common personal tax mistakes and misconceptions, and he told us about one he confronts every year.

ANDY ROSEN: One of the major mistakes people make is just not keeping records of things that they might need to have to prove to the IRS that what they're claiming on their tax forms is true.

NADWORNY: This is key because documents make a difference.

ROSEN: So, for instance, maybe you have some business income and you didn't save the receipts or maybe you made some charitable contributions. They didn't keep track of those. These are mistakes that are kind of hard to rectify unless you can go back to the sources of those transactions and get new records.

NADWORNY: So get access to important documents because they will help you figure out what you owe. And speaking of what someone owes, that leads us to what Rosen says is a common tax misconception.

ROSEN: You've probably heard the term marginal tax rate. And the term essentially sounds pretty complicated, but what it actually is, is just the top rate you paid generally. It's the tax paid on the last dollar of taxable income.

NADWORNY: He breaks down what he means.

ROSEN: Pretty much everyone pays at least some tax in the lowest tax bracket, which is 10%. Whether you made $11,000 or $1 billion in taxable income, you probably pay 10% tax on that first bit of income. The difference is that as your income goes up, additional money you made gets taxed at a higher rate. So you made enough to move you from the 10 to 12% bracket, but only by making $1 above the threshold. You pay $0.12 on that extra dollar and $0.10 on every other dollar you made.

NADWORNY: Another misconception - tax credits versus tax deductions.

ROSEN: A deduction just reduces the amount of income you have to pay tax on. So whatever the size of that deduction, only a percentage of that is going to come off of your tax bill. A credit, on the other hand, is a one-to-one reduction.

NADWORNY: As a result, Rosen says that credits are a more powerful tool for taxpayers.

ROSEN: So say you owe the government $5,000. You get a a thousand dollar tax credit, that cuts your bill to $4,000. And depending on the size and the type of the tax credit you're using, you could even turn a bill into a refund.

NADWORNY: And while we're on the topic of refunds, Rosen says pay attention to yours because it could be a signal.

ROSEN: It might feel nice to get a refund. But if you're getting a big surprise, including a refund or a big bill, it's a sign that you might want to go back to your tax withholding forms and revisit what you're paying to try to get it closer to the amount that you wound up owing.

NADWORNY: Now, Rosen stresses that no one tax situation is the same, so getting professional guidance, even this close to tax day, can help.

ROSEN: If you have simple taxes, maybe just a W-2, and you're taking the standard deduction, that could be different than if your taxes are more complicated. Say your life circumstances have changed. You earned income or lived in multiple states. You're working for yourself and have business income. Then it might be worth thinking about getting someone to help out. But that said, there's a price of peace of mind. And even if you do have simple taxes, you might find that talking to an expert helps you reduce your anxiety over the potential for a mistake or an audit.

NADWORNY: And if that's not possible, there are free resources.

ROSEN: In general, there's lots of places on the internet, including the IRS website, that aim to explain things as clearly as possible. Look. Taxes can be complicated, but in the end, just think about it in a very broad way. Essentially, you're trying to tell the government what you owe and then figure out how much of it is subject to tax, and find different programs that can reduce how much of your income is subject to tax. All of this is going around that simple question.

NADWORNY: That's Andy Rosen. He writes about investing and taxes for NerdWallet, the personal finance website. Transcript provided by NPR, Copyright NPR.