Debunking common tax myths

Tax time comes around every spring—right along with confusion surrounding the many nuances of how your money is taxed.

Further muddying the waters are a number of misconceptions about taxable income, the deductions you can take and more. Here are some of the most common tax myths that the BOK Financial® team encounters and the fact versus fiction in each scenario.

Myth: If you earn more money and move into a new tax bracket, all your income gets taxed at a higher rate.
Many people believe that if they move into a higher tax bracket, their entire income will be taxed at that higher rate. “This misconception can make people worry that earning more will significantly reduce their take-home pay, but it’s not true,” said Chrisanna Elser, financial planning quality assurance specialist at BOK Financial.

Reality: Only the income within the higher bracket is taxed at the higher rate.
Tax systems in many countries, including the U.S., use a progressive tax structure. This means that only the portion of your income that falls within a higher tax bracket is taxed at the higher rate. The rest of your income is taxed at the lower rates applicable to those portions. “A lot of people believe they are taxed at a flat 37% marginal rate, when in fact 37% only applies to income over $730,000 for married couples filing jointly. Plus, not all income is taxed the same, for example, capital gains are taxed at a maximum of 20%,” Elser explained.

Myth: The entire value of a charitable contribution is a dollar-for-dollar tax deduction.
Many people assume that the entire value of their charitable contribution is a dollar-for-dollar tax deduction; however, that is not the case, said Karla Salinas, a financial planner at BOK Financial.

Reality: The amount of your charitable contribution that you can deduct depends on factors such as your income.
The amount of charitable cash contributions that you can deduct on Schedule A as an itemized deduction is usually limited to 60% of your adjusted gross income (AGI), according to the IRS. However, qualified contributions are not subject to this limitation. You can “carry forward” the amount of your charitable contributions that you couldn’t deduct in one tax year to the following tax year, Salinas noted. A tax professional can help you through this process.

Myth: If you pay a mortgage, it’s always better to itemize your deductions, including your mortgage interest, than to take the standard deduction.

Reality: Yes, your mortgage interest is deductible, but that doesn’t necessarily mean you shouldn’t just take the standard deduction. “For most taxpayers, the standard deduction is higher than their itemized deductions would be, so they don’t actually gain any additional benefit from itemizing charitable or mortgage interest deductions,” Salinas said.

Moreover, despite myths you may see on social media surrounding HELOCs and comments that you can obtain one and deduct the interest, certain conditions need to be met—for instance, the funds must be used to buy, build, or substantially improve the residence—for you to deduct the interest you paid, she noted.

Myth: Roth 401(k) contributions are tax-deductible.

Reality: Unlike traditional 401(k) contributions, Roth 401(k) contributions are made with after-tax dollars, meaning they are not tax-deductible. Still, Roth 401(k)s can be an important part of a financial planning strategy—and, contrary to what some people believe, you can contribute to both a traditional 401(k) and Roth 401(k), as long as the combined contributions do not exceed the annual limit set by the IRS, explained Brandy Marion, retirement plans education manager with BOK Financial.

For example, one benefit of a Roth 401(k) is that you can make qualified withdrawals from your Roth 401(k) tax-free in retirement, if you've held the account for at least five years and are at least 59-and-a-half years old. This can help you diversify your income streams in retirement, as withdrawals from your tradition 401(k) will be taxed.

These are just some of the common areas of confusion around taxes that our financial experts encounter regularly. Information in this article should not be construed as tax advice and is offered for general informational purposes only. For individualized concerns or tax advice, please confer with your tax professional.