Why You Might Owe Taxes This Year
Many situations can put you in a position where you’ll owe tax. This can be surprising for some and financially stressful if you’re unprepared for a high tax bill.
Situations That May Lead to You Owing More
Not Enough Tax Withheld
If you’re an employee that receives a W-2, you may be familiar with the concept of withheld taxes. Your employer can withhold federal and state income tax on your behalf and remit it to the respective taxing authorities. The amount that your employer needs to withhold is determined by Form W-4, which you usually complete when you begin working for the company. At the beginning of the year, your company should send you a W-2 that summarizes: what you earned the previous year, the states in which you had income tax withheld, and the associated federal and state taxes withheld and remitted on your behalf. Taxes are withheld based on your income from that particular job. If you work for multiple companies, you may have different percentages of tax withheld. If your only income is from your job(s), and you owe taxes, you probably didn’t have enough tax withheld from your wages. The first thing to do to prevent this from happening again next year is to review the W-4 you have on file with your employer(s). If you’ve been with the same employer for years, it’s possible the W-4 you filled out many moons ago is outdated. You’ll want to correct that by using the updated form and resubmitting it to your HR department. If your W-4 is up-to-date and you have multiple jobs, we might need to work together to see what needs to be updated on your W-4 to ensure you have the proper withholding amount that accounts for your income from both jobs.
Sold an Asset
If you sold a home, stock, bonds, mutual funds, or cryptocurrency, you’ve created a taxable event. Simply put, if you made more money than you spent to acquire the asset, you have a gain. The opposite is true if you made less money than spent. While some rules allow you to exclude income from the sale of your home or certain other assets, you’ll usually see the gain or loss included in your income.
The rate at which gains are taxed depends on how long you “held” or possessed the asset. If you’ve held the investment for longer than one year, you have a long-term capital gain, and less than one year is a short-term capital gain. Long-term capital gains tax rates are generally more advantageous than short-term. Short-term capital gains are taxed as ordinary gains at graduated rates. Even though capital gains rates have increased tremendously in the past few years, it’s still better for tax purposes to hold on to your assets for one year or more before selling.
If you’re self-employed and didn’t make any estimated tax payments throughout the year, you may owe self-employment taxes. Remember that W-2 we mentioned earlier that reports taxes withheld; as a self-employed individual, your income tax isn’t remitted to the appropriate taxing authority regularly. Those taxes withheld for employees are not optional, so as a business owner, it’s your responsibility to now pay those taxes yourself.
Most business owners pay quarterly estimated taxes, which alleviates the possibility of a large tax bill when returns are due. If you didn’t make any payments last year, you might find yourself in a position to owe more than you were anticipating with your return. If you haven’t been saving for tax liabilities or paid estimated taxes and had net income, you’ll most likely owe the federal and state taxing authorities (unless you’re in a state that doesn’t have income taxes).
Scholarships Greater than School Tuition & Fees
If you’re a student at an eligible educational institution, you may be able to deduct or take a credit for your school expenses. Some people may have scholarships and grants that help offset the cost of schooling. When your scholarships, grants, or other financial assistance exceed the cost of your tuition and other necessary expenses (books and other required course material), you have to include the excess in your income. This income may then be taxed, putting you in a position where you might owe.
What to Do if You Owe
Don’t Ignore or Avoid
In some cases, you may owe more than you can currently afford to pay, which may lead you to avoid making a payment. Do not ignore or avoid making a payment. Remember, even though it’s possible to file an extension for your return, that doesn’t extend the deadline to pay your tax obligations.
If you do not pay by the due date, which has often been April 18th, you can be assessed a penalty and interest. We can work together to have a taxing authority reduce or remove penalty charges; however, interest charges usually are not waived. Interest accrues by the day, and while it may not seem like much money at first, let’s put you in the best position to not owe any additional money.
Set Up a Payment Plan
With the IRS and most state taxing authorities, you can set up a payment plan depending on how much you owe. If you can’t afford to make an entire tax payment upfront, you can set up a payment plan so that you don’t get penalized for not paying. Each state has its own taxing body, so you can go to that state’s department website and enroll in a payment plan if you have a state liability that you can’t pay at once.
Ways You Can Reduce Your Future Tax Liability
Check Your Withholding Amounts
If you’re a salaried employee, I often recommend this calculator from ADP and this one if you’re an hourly employee. You may want to check your W-4, make any necessary adjustments, and review some of your pay stubs to see if it lines up with what you’d expect the withholdings to be. If you want to be proactive, calculate the withholding amounts at different pay rates to anticipate how much your take-home pay should be if you’re looking for a new job or hoping to get a raise.
Start Making Estimated Payments
Whether you own a business or owed taxes last year, you’ll want to consider if you should make an estimated payment for the next tax year. If you’re filing with us this year, we’ll let you know if we find you should be paying estimated taxes and give you an estimate on how much your quarterly payments should be based on this year’s filing. Even if you are working with us and would like to get an idea of what you might owe on your own, or based on what you expect to owe in the upcoming year, you can use Form 1040-ES to figure out those estimates.
Strategizing ahead of year-end and being intentional with your finances can lead to lower tax bills down the line. Tax planning should be ongoing, especially if you plan on retiring. By planning, we can make financial decisions now that can put you in a position to have more nontaxable income or utilize different tax deductions and credits.
Questions? Contact us here.