Have you been surprised by an unexpected tax bill? You’re not alone. According to AP News, two-thirds of U.S. taxpayers say they spend “too much” on taxes, as tax season begins. Whether it’s due to investment gains or insufficient paycheck withholdings, there are several reasons your tax bill might be higher than expected. Read on to explore why you owe taxes this year and what steps you can take to address it. Keep reading to see how you can get personalized offers from our trusted partners through MoneyLion!
Reasons why you owe taxes this year
Let’s break it down. Here are several reasons you might find yourself with a tax bill instead of a refund.
1. Changes in overall income
A sudden increase in your income can push you into a higher tax bracket. Maybe you got a promotion or landed a side gig that’s taken off. While those extra dollars are beneficial for your bank account, they can also mean you owe more in income tax.
2. Capital gains from selling investments
Capital gains are defined as the profit from selling an asset, such as a stock, mutual fund, or ETF. Did you sell some stocks or other investments this year? Those capital gains can impact you during tax season. If you made a profit from selling investments, that’s taxable income, and the IRS will want its cut. Whether it’s short-term gains taxed at your regular tax rate or long-term gains with a lower rate, you’ll still need to pay it in taxes.
3. Insufficient tax withholding from your paycheck
You might also owe if your employer doesn’t withhold enough taxes. This can happen if you claimed too many allowances on your W-4 form or didn’t update your withholding after a major life change, namely a change in your marital status, the birth of a child, and purchasing a home. Inadequate tax withholding can leave you with a hefty bill at the end of the year.
4. Loss of deductions or credits
Tax deductions and tax credits can significantly reduce your tax liability. A tax deduction reduces your taxable income, which can reduce the tax you owe, while a tax credit is a dollar-for-dollar reduction to the tax you owe. However, your tax bill could increase if you lose eligibility for certain deductions or credits this year. For example, if your child’s tax credit eligibility changes or you can’t claim the same deductions as last year.
5. Self-employment income without quarterly tax payments
Being self-employed has its benefits, but it can be challenging when tax season arrives. If you have self-employment income but didn’t make quarterly tax payments, you’ll owe taxes in addition to possible penalties. The IRS expects self-employed individuals to pay taxes as they earn, not just at the end of the year.
6. Withdrawal from a retirement account
Did you withdraw from your 401(k) or IRA? A 401(k) is an employer-sponsored retirement plan, and an IRA is an individual retirement account that is opened through a bank or a brokerage firm. Withdrawals from retirement accounts are usually considered taxable income. Unless it’s a qualified distribution, early withdrawal from an IRA prior to age 59.5 is subject to being included in gross income plus a 10 percent additional tax penalty.
7. Updated your FSA or HSA contributions
Changes to your Flexible Spending Account (FSA) or Health Savings Account (HSA) contributions can also affect your taxes. For instance, if you didn’t use all your FSA funds, that remaining money might be considered taxable. Similarly, you might miss potential tax savings if you didn’t max out your HSA contributions.
8. Significant changes in your life
Major life changes like getting married, changing jobs, buying a house, or having a kid can all affect your tax status. These changes can alter your tax bracket, eligibility for certain deductions or credits, and overall tax liability.
What should you do if you owe taxes?
If you owe taxes, what should you do next? Here are steps to manage paying your taxes.
- File your return on time: If you can’t pay up your taxes immediately, file your tax return on time to avoid late-filing penalties.
- Set up a payment plan: The IRS offers payment plans if you can’t pay your tax bill in full. You can apply for an installment agreement to spread out the payments over time.
- Consider a loan: Consider getting a personal loan or credit card if the interest rate is. lower than the IRS’s late payment penalties.
- Adjust your withholding: To avoid the same issue the following year, adjust your tax withholding or make estimated tax payments.
How much should you save for taxes in advance?
Planning is key when paying taxes. A good rule of thumb is to save at least 15-30% of your income for taxes if you’re self-employed. Make sure to review your withholdings regularly, especially after major life changes. In addition, consider placing your tax savings in a savings account to earn interest over time.
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How can you avoid owing taxes at the end of the year?
Prevention is better than cure. Here’s how you can dodge a hefty tax bill next year.
Keep accurate and organized records of income and expenses all year
Accurate records ensure you’re reporting correctly and can claim all eligible deductions. Track your income and expenses meticulously to avoid surprises.
Pay estimated taxes quarterly
Pay estimated taxes quarterly if you have non-wage income, like self-employment or investments. This helps spread out your tax liability and avoid a massive bill in April.
Stay informed about changes in tax laws and regulations
Tax laws can change, affecting your liability. Stay updated on new tax regulations to plan accordingly.
Review and adjust tax withholdings on paychecks
Check your withholdings regularly, especially after life changes. Adjusting your W-4 form can help ensure the correct amount is withheld.
Consult with a tax professional or accountant
A tax professional can provide personalized advice, ensure you’re taking advantage of all deductions and credits, and help you plan better for the future.
What happens if you owe more taxes than you can pay?
If your tax bill is more than you can handle, don’t panic. The IRS offers options:
- Installment agreements: Pay your tax debt over time through monthly payments.
- Offer in compromise: Settle your tax debt for less than the full amount you owe if you meet certain conditions.
- Temporary delay: Request a delay in collection if paying would cause significant financial hardship.
Stay Ahead of Your Taxes
Owing taxes isn’t the end of the world, but understanding why it happens and how to prevent it can save you a lot of stress. Keep track of your income, withholdings, life changes, and plan. If you owe, take advantage of IRS payment options and consult a tax professional to navigate the complexities.
FAQ
Can cancellation of debt lead to owing taxes?
Yes, canceled debt is generally considered taxable income by the IRS, and you may owe taxes on the amount forgiven.
How do errors on my tax return affect what I owe?
Errors on your tax return can lead to underpayment or overpayment of taxes. If the IRS discovers the error, you may owe additional taxes, interest, and penalties.
Can claiming too many tax credits result in owing taxes?
Claiming tax credits usually reduces your tax bill, but if you claim credits you’re not eligible for, the IRS can disallow them, leading to a higher tax bill.
