5 Common Reasons Why You Might Owe Taxes This Year
Although most types of income are taxed, there are several reasons why you might owe the Internal Revenue Service, despite having money withheld from your paycheck all year. Explore some of the most common explanations for owing taxes and how you can avoid making underpayments in the future. Plus, find out what to do if your tax bill is exceptionally large and what payment options you have to get yourself out of tax debt with the IRS.
Even if you end up owing taxes, there are plenty of resources available to help you get back on track. To help you learn what to do every step of the way, this guide will cover the following topics:
- What Is Withholding Tax?
- 5 Reasons Why You Might Owe Taxes
- What Happens If I Don’t Pay My Taxes?
- What Happens If I Owe Too Much in Taxes?
- What Can I Do If I Owe Taxes?
- How Does Tax Reform Impact Withholding?
- How Do I Avoid Owing Taxes in the Future?
- Understand Your Tax Situation
To understand why you owe taxes this year, you need to know how income tax works. Most working Americans pay taxes to the federal government and their state government on their earnings each year. From a federal perspective, withholding tax is the amount taken out of your paycheck and paid directly to the government before you even see it. In most cases, you’ll pay a withholding tax for your state taxes as well, although there are a few states that don’t charge income tax.
Your employer will base the withholding amount on how much money you earn, as well as other important details you provide on your Form W-4. If you don’t fill out this form correctly, you could have too little taken out of your paycheck each pay period, ultimately resulting in underpaying your taxes.
Figuring out why you owe taxes is important so you can make sure it doesn’t happen again in the future. While everyone’s situation is unique, some common explanations can shed light on the problem. Here’s a look at five possible reasons for owing taxes.
Withholding Too Little From Your Paycheck
The amount taken out of your paycheck throughout the year is an estimate of what you’ll owe when it comes time to file your taxes. If you overpay, you’ll receive a tax refund. But if you don’t pay enough throughout the year, you’ll end up with a bill come tax season.
Related: How To Minimize Tax Debt
Failure To File
Another potential issue resulting in owed taxes is the failure to file them on time. Generally speaking, the annual due date for federal taxes is April 15 (May 17 in 2021). State tax due dates may vary. When you file late and don’t apply for an extension on time, you could incur late fees and interest that make your tax bill higher. If you’re wondering why you owe taxes this year, the reason might be because you submitted your tax return after the due date.
Please note that The IRS has announced that the federal income tax deadline for individuals is May 17, 2021 for the 2020 tax year. State deadlines have not changed, however, so make sure to confirm your state’s due date before you file.
Changes in Tax Code
There have been several changes in the tax code in recent years that could significantly impact how much you pay in taxes. Even if you typically expect a refund, this may not be the case with new tax laws. When the IRS updated its tax brackets, it may have impacted you and put you in a new category.
Higher Income Than Usual
Earning more means you’re taxed more. Whether you earned a salary raise or worked a lot of overtime while getting paid hourly, either of those situations could have bumped you into a higher tax bracket.
Changes in Deductions
You might also owe taxes this year if you didn’t qualify for deductions and credits you’ve come to expect. The earned income tax credit, for example, comes with annual limits. If you made more than you earned the previous tax year, you might not qualify anymore. Similarly, many parents take advantage of the child tax credit, which can significantly reduce the amount of taxes you owe. This credit also comes with income limits, or maybe your child aged out of eligibility.
Unfortunately, not paying your taxes doesn’t make this debt go away. Assuming you didn’t file for an extension, if you don’t pay your taxes by the due date, you’ll end up owing back taxes. Whether it’s intentional or not, prioritize paying your back taxes as soon as you realize that you owe them.
The IRS should send you a letter explaining how much you owe. If your situation is complicated, you can also consult with a tax professional or financial planner to help you understand your options. The worst thing to do is to not do anything at all. Take action so you can work something out and get your tax bill behind you once and for all.
There might be a couple of reasons contributing to an extremely high tax bill. For example, underpaying throughout the year can result in a tax underpayment penalty. If you paid at least 90% of your taxes, the fee is waived. But if you were significantly off the mark on your tax payments, you’ll likely owe money to the IRS.
Owing too much in taxes may also result in an IRS audit. This process verifies your financial information to ensure your taxes are accurate.
If your employer doesn’t withhold taxes or you earn additional income through a side hustle, you should pay your taxes quarterly. This can help you avoid an underpayment penalty.
Also, learn how to avoid tax evasion, which can come with major consequences.
If you can’t pay your entire tax bill when it’s due, there are a number of options available to help you avoid serious consequences. Some involve working out payments directly with the IRS, while others involve finding alternative ways to pay your taxes.
Here are some payment options to consider:
- Apply for a full-payment agreement if you can pay your taxes within 120 days
- Sign up for an IRS installment plan
- Make an offer in compromise
- Consider a loan or other financing to make a tax payment
Each of these options comes with different eligibility requirements and consequences. This is especially true when you think about taking out a personal loan, home equity loan or another type of financing to take care of your tax bill.
Changes in tax law can impact how much you owe the federal government each year. While minor changes happen frequently, the Tax Cuts and Jobs Act of 2017 brought significant changes for both individuals and businesses.
One of the major changes for individuals is that standard deductions have become much higher. On the flip side, the Tax Cuts and Jobs Act also eliminated personal exemptions. IRS rules also impact claiming your boyfriend or girlfriend as a dependent in some situations.
Many people are disenchanted with the current tax system: Only 18% of respondents in a recent GOBankingRates survey believe that their taxes are being spent effectively. This frustration may end up affecting tax policy — so it wouldn’t hurt to pay attention to tax reform measures and to cast your ballot in the next election.
It’s important to research ways to avoid owing taxes in the future. Here are some ways to get started, so next year you won’t have to ask, “Why do I owe taxes this year?”
- Update your W-4 annually or when anything changes your tax situation.
- File your taxes early to avoid underpayment and other penalties.
- Speak to a CPA and a financial advisor to get the big picture of your finances and make sure you’re maximizing your deductions.
- Use the IRS Tax Withholding Estimator to estimate how much you’ll owe next year.
Following these steps each year can help you make sure you’re withholding the correct amount in each of your paychecks so you won’t get caught off guard when you file your taxes.
Even if you owe taxes this year, use it as a learning opportunity to understand your finances better for the future. Keep track of how much you earn, what methods you use to earn money, and how your life changes over time. It’s also smart to stay on top of tax-related news so you know about major changes that might affect you. Of course, anytime you’re in doubt about how much you owe or what your payment options may be, talk to a professional. It’s the best way to protect yourself and keep the IRS happy.
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Last updated: Mar. 18, 2021