IRS myths: They sound too good to be true

The U.S. tax code is massive and complicated — the perfect fodder for myth-making.

Perhaps the most well-worn fallacy — shot down by many courts despite the best efforts of tightfisted taxpayers — is that federal taxes are actually illegal.

It’s an argument often used by people who have turned to Tax Masters, which helps filers in trouble with the IRS, says company president Patrick Cox. Some clients have claimed they don’t owe U.S. taxes because they are “citizens of the world.” If that were the case, maybe they should be paying taxes to the United Nations, Cox jokes.

Many myths involve audits. That’s understandable, given that the IRS doesn’t dish details on what triggers an audit, leaving us to speculate. Some tax legends maintain that the IRS will give your return an extra hard look if you call the agency to ask a question.

“Not true,” says IRS spokesman Jim Dupree. “If someone asks a general tax question, we aren’t going to ask who they are.”

To help separate fact from fiction, here are some common myths:

Income taxes are unconstitutional. Pick an amendment — from the right to free speech to protections against self-incrimination and involuntary servitude — and tax protesters have used it to justify not paying taxes. In particular, the 97-year-old 16th Amendment, which authorized Congress to enact our current tax system, has long been under attack.

“There are some people in jail who argued that the 16th amendment was never ratified,” says Eddy Quijano, an instructor at California Polytechnic State University and a former IRS lawyer.

Actor Wesley Snipes, who argued he wasn’t legally required to pay taxes, may soon join other so-called tax deniers in jail. He was convicted of failing to file tax returns in 2008, and remains free while appealing his three-year prison sentence.

Similarly, some argue that because we have a “voluntary” system, taxes are optional. But voluntary only “means the government is trusting you to self-report how much tax you owe,” instead of the government telling you what you owe, says George Willis, an associate clinical professor at Chapman University School of Law.

Bartering is tax-free. Bartering has blossomed in the recession, particularly online. But while no money changes hands, the value of the swaps is taxable income for both sides, Quijano says.

Internet revenue isn’t taxable. Online entrepreneurs who believe this are in for a rude shock next year, says Barbara Weltman, author of J.K. Lasser’s 1001 Deductions &Tax Breaks. That’s when credit card companies and groups like PayPal must start reporting merchant sales to the IRS, she says.

Ill-gotten gains aren’t taxable. Even if your line of work is theft, embezzlement, prostitution, drug dealing or some other illegal enterprise, that income is still taxable.

Take bribing a senator. “The senator should report the bribe,” Willis says. He quickly adds: “The bribe is not deductible to the payer.”

Cash isn’t taxed. Tips, gambling winnings, extra bucks you earn under the table and money you find on street must be reported to the IRS and is subject to tax.

“The law requires reporting all your income, even if it’s not on a Form 1099 or W-2,” says Zack Goff, a senior tax analyst with The Tax Institute at H&R Block.