Seven Misperceptions About Taxes
Since tax payment season is just around the corner, I thought I’d share some common misperceptions about your federal taxes.
Getting refunds is better than owing taxes. False. A refund is nothing more than a zero-interest loan you made to the government. It’s better to owe them money. But not too much. If you owe more that 10% of your total tax for the year when tax returns are due they will charge you interest on it (they call it a penalty) unless you prepaid at least 110% of the previous year’s tax amount. I know; it doesn’t seem fair that they can charge interest on underpayments but we can’t do the same on overpayments. Go complain to your Representative.
A tax bracket is the rate at which all my income will be taxed. False. A bracket is the marginal rate at which additional income will be taxed. Your total tax is the average tax owed across all tax brackets in which your income falls and will always be less than the bracket you’re in. For example, if your 2022 taxable income is $100,000, you are in the 22% tax bracket (married filing jointly). But your total tax, which is also based upon income in the 10% and 12% brackets, will only be $13,234 rather than $22,000.
I don’t pay taxes on foreign income. False. The U.S. is one of only a few countries in the world that taxes its citizens no matter where they live. To avoid double taxation, the U.S. maintains tax treaties with numerous countries (including, perhaps surprisingly, Russia). But if you work in Singapore or Brazil, for example, you will be double-taxed.
I won’t have to pay taxes in retirement since I’m no longer working. False. As much as 80% of your Social Security income will be taxed, as well as dividends, interest and capital gains on investments in banks & brokerage accounts. And if you have an IRA or 401(k) you will face annual required minimum distributions (RMDs) which are fully taxable.
Tax-loss harvesting (TLH) eliminates taxes. False. TLH is a methodology involving selling securities at a loss to offset those sold at a gain and then buying back the former (with some caveats) in order to reduce the taxes owed on the gains. It does reduce taxes in the year it is executed (and in future years if you have capital loss carryovers). But it increases the gain on the future sale of the repurchased securities as compared to not having sold them in the first place. In other words you are really postponing taxes, not eliminating them.
A tax write-off is free money. False. If you are considering an expense that can be written off your taxes, the tax savings will always be less than the expense. It makes no sense to incur the cost of the expense solely to get the tax write-off.
A tax extension gives you more time to pay your taxes. False. An extension gives you more time to file but you still have to pay an estimate of what you think you’ll owe by April 15th. And if you don’t pay enough (see point 1 above) you’ll be assessed a penalty.
Note that as a result of the damage caused by the December & January storms, the due date for 2022 federal and state tax payments for all taxpayers in Santa Clara and certain other Bay Area counties has been delayed from April 17th to October 15th. See https://www.gov.ca.gov/2023/03/02/more-time-to-file-state-taxes-for-californians-impacted-by-december-and-january-winter-storms/. That’s a rare gift from the federal and state governments.
Good stuff, minor correction, the maximum social security claw back tax rate is 85%, not 80%.