From the millions of words in the Internal Revenue Code and Regulations and the body of state tax law have emerged a number of popularly held perceptions not in accordance with law or common practice. Here are 10 of the top myths:
All Legal Fees Associated with Alimony are Deductible.
FALSE. While the potential recipient of alimony may deduct the portion of legal fees related to attempting to receive alimony as a miscellaneous itemized deduction, it is well established that the cost of defending against a claim for marital support is nondeductible except for tax advice.
IRS Doesn’t Care about Forgiven Debt.
FALSE. Under the general rule, relief of indebtedness is taxable to the debtor because it represents an accretion of wealth. Exceptions include gifts, most settlements of disputed debts, tax compromises, indebtedness discharged in bankruptcy and debt discharged while insolvent, but outside of bankruptcy. Discharge of acquisition indebtedness on a principal residence is tax free through 2012 even if you are solvent.
Allocation in an Asset Sale of a Business is Best Left to the Accountants at “Tax Time.”
FALSE. Huge tax dollars can be saved by a favorable asset allocation when a business is sold. Unfortunately, an allocation that is favorable to one party is almost always adverse to the other. When the seller is a ‘C’ Corporation, avoidance of double taxation through appropriate allocation to an individual covenant not to compete or to personal goodwill is particularly important. What constitutes personal versus institutional goodwill is as “hot” a tax issue as it is a family law issue in Maryland.
Filing an Extension Increases Your Chances of Audit.
FALSE. No indication exists of a correlation between extensions and audits. Most returns are selected for scrutiny after a live person looks at a return assigned a high computerized point score based on line items and ratios. This screening occurs after the extended due date of the return. More complex individual returns and those reflecting higher income have a greater chance of audit irrespective of filing by April 15 or October 15.
Innocent Spouse Status is Easy to Obtain.
FALSE. If you have filed a joint return, receiving innocent spouse status requires that IRS determine you are entitled to “equitable relief” based on the balancing of a number of factors. If liability has arisen through audit, obtaining innocent spouse status becomes easier especially if you had no knowledge of the errors and you are either divorced or have lived apart for 12 months. Nonetheless, recent statistics indicate that less than 20 percent of all innocent spouse applications are accepted in full.
IRS Approves Most Offers in Compromise.
FALSE. Despite what you may have heard through television advertising, you are almost never a candidate for an Offer in Compromise if you have equity in your assets or family income in excess of about $75,000. Acceptance rate for all Offers is only about 20 percent.
Taxes Are Never Dischargeable in Bankruptcy.
FALSE. While trust taxes, such as sales tax collected from customers and withholding collected from employees, are never dischargeable in bankruptcy, income taxes are generally dischargeable once three years have elapsed from the due date of the return, including extensions, and two years have passed from the actual date of filing. In the case of an audit, 240 days must have passed from the date of assessment. Certain tolling rules apply. An income tax debt will be nondischargeable in cases of fraud and, at least in the Fourth Circuit, if IRS filed a substitute for return (SFR) before your actual filing.
Most Families Face Death Taxes.
FALSE. In 2009, less than 15,000 decedent estates nationally paid federal estate taxes – only 262 in Maryland. With the exemption increased at least through 2012 to $5 million, these numbers will further decline. While more Maryland decedents pay state estate taxes due to a $1 million exemption and state inheritance taxes due to bequests to distant family or friends, most deaths in and out of Maryland do not generate death taxes.
State of Incorporation is Important to Saving Taxes.
FALSE. Business income is apportioned by formula among the states where there are sales, property and/or payroll and not to the state of incorporation. Portfolio income such as interest or dividends is generally allocated to the situs of the corporate office and not to the state of incorporation. Ignore the ads in airline magazines implying the contrary.
Moving Out of the Country Avoids State Taxes.
FALSE. Maryland or any other state in which you last lived continues to have the right to tax you on worldwide income unless you have clearly established domicile outside the country. You must show an intent to live abroad indefinitely by obtaining resident or similar status and by establishing ties there while severing most connections to your home state.