While filing your taxes, you may discover to your dismay that you owe the IRS money. This is a common scenario. As you read this article, you will discover 6 potential causes for your owing additional tax. Keep in mind that owing the IRS money may mean you’ve earned extra income.
Typical employees receive a W-2 from their employer at the end of the year showing all their income as well as all income withheld from that year. The withheld income is based on how the employee fills out their W-4 form.
Based on the completion of the W-4, the employer will be required to withhold the appropriate amount of tax for the taxable year and remit the withheld amount to the IRS. As an employee, this may create confusion for you if you owe the IRS money.
1. W-4 Form
An incorrectly completed W-4, or inaccurate or outdated W-4 may be the reason you owe the IRS additional tax. You may have been married and filing jointly when your employer hired you, in which case you accurately selected “married filing jointly” in section “C” of the W-4 form, but then got divorced in the following year and did not think to update your W-4.
This would cause your employer to withhold too little income, which would cause you to owe money at the end of the year when you file your 1040 and select “single” on the first line.
2. Change in Filing Status
If you were previously married and filing jointly and your spouse did not earn any income, you would need to earn more money by yourself to be in a higher tax bracket. However, if you get divorced and are now filing as “single” you could earn less money but still be in a higher tax bracket causing you to owe the IRS money.
Alternatively, you may have had a dependent child last year but now your child is 18 and no longer considered a dependent child. This too could cause you to lose a child tax credit, increasing your tax liability.
IRS Publication 505 lists additional reasons why your withholding may be insufficient due to a change in your circumstances.
3. Additional Income
In addition to your W-2 employee wages, you may have additional income resulting in self-employment taxes. You are considered “self-employed” if you are a sole proprietor, contractor, or partner in a partnership engaged in a trade or business or otherwise in business for yourself. If you have self-employment income you are required to pay what is called “self-employment” tax.
As a self-employed individual, generally you are required to file an annual return and pay estimated tax quarterly.
Self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners but instead is required to be withheld by you on your own. In general, the wording “self-employment tax” only refers to Social Security and Medicare taxes and not any other tax (like income tax).
4. Early Retirement Account Withdrawal
When you contribute a portion of your income to a retirement account, the amount contributed to the retirement account is deducted from your earned income and does not have to be reported on your tax return as income. Instead, you would deduct your IRA contributions on Form 1040, Schedule 1, Part II – Adjustments to Income. Retirement accounts eligible for these deductions are Individual Retirement Accounts (IRA’s) or 401(k)’s through your employer.
The contributions to the retirement accounts may grow tax-free until you reach the legal retirement age, or the required minimum distribution age of 72. However, you may elect to take earlier distributions from your retirement accounts as early as age 59 ½. If you take early withdrawals from your retirement accounts you may be subject to early withdrawal penalties. You will be required to pay tax on the income at ordinary income rates plus a penalty of an additional 10% on the amount you withdraw.
For example, assume you are 40 and withdraw $10,000 and you are in the 20% tax bracket. You will be required to pay $2,000 in ordinary income tax plus an additional $200, or 10%, of the amount withdrawn.
There are exceptions to the 10% penalty, however, and it’s good to familiarize oneself with them in case any of them apply.
5. No Longer Qualify For Tax Credits
If you previously had dependent children under the age of 18 and those children reached the age of majority, or 18, and no longer qualify as dependent children you may be required to pay additional tax until you update your W-4 if you are an employee, or increase your self-employment and estimated quarterly payments.
6. Low Estimated Tax Payments
If you are a sole proprietor or contractor, you are required to make estimated tax payments quarterly. If those payments are too low, you may owe tax at the end of the year.
The IRS states in Publication 505 as follows:
“If you don’t pay your tax through withholding, or don’t pay enough tax that way, you might have to pay estimated tax. People who are in business for themselves will generally have to pay their tax this way. You may have to pay estimated tax if you receive income such as dividends, interest, capital gains, rents, and royalties. Estimated tax is used to pay not only income tax, but other taxes such as self-employment tax and alternative minimum tax.”
What Happens If I Don't Pay My Taxes This Year
Any time you owe the IRS money for a taxable year and do not pay the tax, the IRS will charge you interest on the amount you owe on a monthly basis. Even if you file a timely extension, the IRS will begin charging interest on any amount you owe from the date the return was due, not including extensions. Interest may also be added to any penalties charged for various reasons, such as understating your income.
How Will I Know Why I Owe Taxes
If you’re using an online tax filing software such as TaxAct or TurboTax, the system will typically notify you that you owe tax upon the submission of your return. If you’ve already filed your taxes and the IRS believes you owe additional tax, they will only contact you via mail to notify you of any money owed.
It is important to contact a tax professional, either a CPA or tax attorney, to go over any correspondence from the IRS as it could be that the IRS is incorrect and therefore nothing is owed. Even if it’s determined by the tax professional that you do not owe money, you should always respond to the IRS’s notice. Do not ignore their notices as it will only get worse. The sooner you respond, the quicker you can reach a resolution.
Why Do I Owe So Much In Taxes? What Can I Do About It?
Owing the IRS additional tax is never fun, but it’s important to know that there are things you can do to prevent this from happening again and to assist you with paying the tax.
If you find that you cannot pay the full amount by the filing deadline, you should file your return and pay as much as you can by the due date. To see if you qualify for an installment payment plan, attach Form 9465, “Installment Agreement Request,” to the front of your tax return. The IRS has streamlined the approval process if the amount owed is not more than $25,000 and can be paid off within a five-year period. Be sure to show the amount of your proposed monthly payment and the date you wish to make your payment each month.
Tax Shark can help assist taxpayers with tax liability payoffs for taxpayers unable to bear the payment of the IRS.
Here are the answers to some common questions about why you owe more taxes this year.
If you earn income as a contractor or sole proprietor and make accurate estimated quarterly tax payments, you should not owe taxes at the end of the year. It is difficult, to accurately make estimated payments if your income fluctuates and this could cause you to owe tax at the end of the year.
There are a number of potential reasons for this, but one potential reason could be that there was a change in the tax laws which either removes a tax credit that you previously qualified for or places you in a higher tax bracket.
It’s better to be owed a refund from the IRS than to owe the IRS money. The primary reason for this is that the IRS can tack on penalties and interest to the amount you owe.