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Debunking Common Tax Misconceptions

Submitted by Bay Point Wealth Management on October 28th, 2015

Filing an extension will increase your chances of an audit by the IRS.

FALSE. There is no relationship between requesting an extension to file your return and being chosen for audit by the IRS. Audit selection is generally determined by a secret IRS computer algorithm combined with human review. Screening only begins after the extended due date of the return and is done on a blind basis. Complex returns and returns reflecting higher income have a greater chance of audit, irrespective of the April 15 versus the October 15 deadline.

You do not have to report the forgiveness of debt as income on your tax return.

GENERALLY FALSE. Relief from indebtedness is generally taxable to the debtor in the year the debt is written off. Exceptions include gifts, most settlements of disputed debts, tax compromises, indebtedness discharged in bankruptcy and debt discharged while insolvent, but outside of bankruptcy.

Taxes can never be discharged in bankruptcy.

GENERALLY FALSE. Trust taxes, such as sales tax collected from customers and withholdings collected from employees, are never dischargeable in bankruptcy, but income taxes are generally dischargeable three years after the due date of the return, including extensions, or two years after the actual date of filing, whichever is later. In the case of an audit, taxes are dischargeable 240 days after the date of assessment. Taxpayers should also be mindful that certain tolling rules apply and that fraud can be a bar to dischargeability in some jurisdictions, including Maryland.

Death taxes affect everyone.

FALSE. In Maryland, taxes are only due for estates larger than $1.5 million (for tax year 2015) and on bequests to distant family or friends. Currently, federal taxes are only due on estates larger than $10.86 million.

It’s easy to get an Offer in Compromise approved by the IRS.

GENERALLY FALSE. While the IRS has relaxed its criteria for acceptance in recent years, the acceptance rate for all Offers is still only about 42 percent. The ideal candidate must be able to demonstrate fixed expenses that meet or exceed projected income and limited equity in whatever assets he/she holds.

You can escape state taxes by leaving the country.

GENERALLY FALSE. Your state of residence has the right to tax you on your worldwide income unless you have clearly established domicile outside the country by showing an intent to live abroad indefinitely by (1) obtaining resident or similar status in the foreign country, (2) establishing ties abroad and (3) severing most connections to your home state.

Where a business incorporates is critical to saving taxes.

GENERALLY FALSE. The vast majority of business income is apportioned by a formula, which typically divides income amongst various states based upon the amount of sales, property and/or payroll in that state, not on the state of incorporation. Portfolio income such as interest, dividends or capital gain on the sale of investment stock is generally allocated to the situs of the corporate office and not to the state of incorporation. Consequently, where a business actually operates is generally more important than where it incorporates, at least for state income tax purposes.

You should wait until “tax time” to conduct an allocation in an asset sale of a business.

FALSE. Huge tax dollars can be saved with a favorable asset allocation when a business is sold as opposed to waiting until March or April. However, taxpayers should be mindful that an allocation that is favorable to one party is almost always adverse to the other.

You can deduct all legal fees related to securing or defending against alimony payments.

FALSE. Taxpayers may deduct legal fees related to attempting to secure alimony payments as a miscellaneous itemized deduction, but defending against a claim for marital support is nondeductible, except for attorney’s fees specifically related to tax advice.

It’s easy to get “Innocent Spouse” relief if your spouse is the responsible party.

FALSE. Less than 30 percent of all innocent spouse applications are accepted in full. Furthermore, in order get such relief, the claiming spouse must often demonstrate that a series of equitable factors, including economic hardship, abuse, poor health, no legal obligation to pay the liability, etc., tips in their favor and he/she had no actual or constructive knowledge of the offending spouse’s liability.