The Paycheck Gaps Most Workers Don’t Notice Until Tax Time
Written by
Cara Danielle Brown
Edited by
Zuri Anderson
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The “paycheck gap” refers to gross pay versus net pay — or what workers think they’re earning on paper versus what they’re actually keeping after paying taxes to the IRS, according to Andrew Latham, certified financial planner (CFP) and content director at SuperMoney.com.
Unfortunately, many people don’t become aware of this gap until filing season. And that means owing a much larger tax bill than anticipated.
Here are a few groups for whom the paycheck gap is most noticeable — and most unexpected.
Regular W-2 Employees With Major Life Changes
Employers withhold income tax, Social Security and Medicare from each paycheck. So nothing should be owed in April, right?
Not necessarily. An employer withholds a specific amount based only on what information you provide on your W-4 when first hired — but your circumstances may evolve (i.e. you get married or pick up a side gig).
Workers often forget to update their W-4s, and this oversight can result in too little withholding and owing more money than expected. This paycheck gap is frequently “sneakier than people realize,” Latham explained.
Workers With 2 W-2 Jobs
If you have one job that pays $43,000 annually and another job that pays $18,000 annually, each withholds like they’re your only job. However, the combined income may place you in a higher tax bracket, resulting in a larger bill to the IRS than anticipated. In this scenario, that means an additional $1,500 to $3,000 owed.
1099 Gig Workers
When it comes to 1099 gig workers (commonly referred to as independent contractors or freelancers), “the paycheck gap isn’t a gap; it’s a canyon,” Latham stated. Because zero dollars are withheld, workers may feel like they are earning more money than they actually are.
But when income taxes and self-employment tax are due in one lump sum in April, individuals are rudely awakened. Per Latham, a gig worker earning $65,000 annually may have a $12,000 to $15,000 bill due to the IRS.
Workers With 1 W-2 Job and 1 or More Side Gigs
Picking up side gigs in addition to your regular 9-to-5 often can also push workers into a higher tax bracket than they planned, according to Leslie H. Tayne, Esq., finance and debt expert and founder of Tayne Law Group. And that means owing more money in April.
Tayne advised keeping proper documentation and writing off all necessary business expenses in order to reduce taxable income.
Individuals With a High Yield Savings Account
Latham explained that individuals earning 4% interest on their $30,000 high-yield savings account earn approximately $1,200 in annual, taxable interest. Unfortunately, an employer’s withholding knows nothing about that account.
Workers can, therefore, be disappointed to realize — after all the pieces are put together — that what they thought would be a $400 tax refund turns out to be a $150 bill. Similarly, 1099 gig workers may be surprised by the additional money owed if they forgot to budget for it.
Want to avoid surprises? “My best piece of advice is to plan for taxes throughout the year, not just in April,” Tayne said. In other words, budget accordingly.
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