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When you earn income in the United States, taxes are usually unavoidable. Although most people try to make sure their state and federal tax bills are covered by withholdings or payments made during the year, many will still owe a certain amount of taxes to state or federal governments when they file their return the following April. Below is some information to help you answer the question “why do I owe taxes?
Every year, your federal and state taxes are calculated based on the amount of income you earn and your filing status. If you file your taxes jointly with a spouse, the spouse’s income will affect your tax liability as well. Other factors, such as tax deductions and tax credits, may decrease your baseline tax liability. While tax deductions lower the amount of your taxable income, tax credits reduce your tax liability dollar-for-dollar. Tax credits can even be refundable at times, allowing you to receive a larger refund if you qualify to claim them.
For most people who earn their income as employees, a portion of federal and state taxes are withheld from every paycheck. The goal of withholding is to spread your tax liability over time so that you won’t be surprised with a tax bill at the end of the year. For people who are self-employed, however, taxes are not typically withheld from wages. Instead, self-employed people are expected to make estimated tax payments at regular intervals throughout the year to ensure that they don’t owe any money in April. Unfortunately, even the best laid plans won’t always prevent a future tax bill. Far too many people file their tax return expecting to receive a refund, only to learn that they owe money to the IRS and/or the state.
Why Do I Owe Federal Taxes?
Even when you are making your estimated tax payments and/or you are having money withheld from employer checks, you may still find that you owe the IRS in April. This situation can develop for a variety of different reasons. Some of the situations that may lead to an unexpected federal tax bill are listed below.
1. You didn’t have enough money withheld from your paycheck.
As an employee, your employer is typically required by law to withhold a certain amount of money to cover your federal tax liability. The amount of money withheld will depend on the way you complete Form W-4, which includes information about your employment income, income from other sources, filing status and the number of dependents you can claim on your tax return. This amount will also be based on the current IRS withholding tables, which are subject to change over time.
Even though this form is designed to make sure the proper amount of money is withheld from your check, it isn’t a perfect system. In some cases, too little money may be withheld, causing you to owe a tax bill you were not expecting. This is more likely to occur if you completed any part of the form inaccurately, or if you have income from other sources that are not subject to withholding and were also omitted from your W-4. In other cases, it may simply occur because the withholding tables were not accurate for your unique tax situation.
You can avoid a tax bill the following year by correcting any errors on your W-4 and/or requesting extra withholding at the bottom of the form.
2. You owe penalties.
In some cases, your tax bill may increase over the expected amount because you owe interest or penalties. For example, if you fail to file on time, you may have a penalty assessed that will cause you to owe money to the IRS, even if you had the proper amount withheld during the year.
3. You earned more income than expected.
Your withholding is usually calculated based on your expected earnings during the year. If you made more money than originally expected, you may be pushed into a higher tax bracket that causes you to owe a tax bill at the end of the year. In most cases, earning extra income at your primary job is less likely to result in this situation, as your employer will be withholding for taxes accordingly. However, if you have multiple jobs, an increase in earnings at one or more of them will have a greater potential to cause a tax liability in April.
Earning extra income can also affect your tax liability significantly if you are self-employed. If extra income pushed you into a higher tax bracket, it is likely that your estimated taxes won’t be high enough to cover your total liability.
4. Missed deductions or credits.
Tax deductions and credits go a long way toward lowering your tax bill. If you completed your taxes on your own, you may have neglected to claim one of these benefits, causing you to owe an unexpected payment to the federal government. In other cases, you may have been expecting to be eligible for deductions or credits that you did not ultimately qualify for. Losing these benefits, especially if they were in the form of a credit, can easily cause you to owe money to the IRS at the end of the year.
5. You didn’t make estimated tax payments.
If you are self-employed, you may have hoped that you would have enough expenses to reduce your income and avoid paying taxes. However, if you ultimately failed to accomplish this goal, you will undoubtedly owe money at the end of the year. In many cases, this situation arises because self-employed taxpayers fail to account for the self-employment tax, which is intended to cover Social Security and Medicare. This tax is twice as high as payroll tax, since self-employed taxpayers are responsible for covering the employer portion of the tax as well.
Why Do I Owe State Taxes?
Every state is different, and tax laws are unique. However, in the majority of states, the reasons for an unexpected tax bill will be similar to those that apply at the federal level.
1. You may not have had enough money withheld from your income during the year to cover your state tax liability.
This may occur if withholding forms were not completed properly, or if your situation changed unexpectedly during the year. Many state tax forms still allow employees to select a specific number of exemptions. If you chose to include too many exemptions, a state tax bill is likely. To rectify this situation in the following year, complete a new withholding form with fewer exemptions.
2. You may have been bumped into a higher bracket.
As with federal taxes, earning more income than originally expected can force you into a higher tax bracket, causing you to owe a tax bill. Likewise, if the state unexpectedly changed its tax code, you may fall into a higher tax bracket even with the same amount of income.
3. You may owe penalties.
Most state taxing authorities will assess penalties if you didn’t pay estimated taxes on time, failed to file your tax returns on time or have been guilty of another violation. These penalties may cause you to owe taxes at the end of the year unexpectedly.
4. You didn’t pay estimated taxes.
Just like the federal government, most state governments will require you to make estimated tax payments during the year if you anticipate owing taxes on self-employment income. If you didn’t make these payments during the year, you may owe money to the government when you file your return.
Why Do I Taxes This Year and Not Last Year?
Perhaps the most frustrating situation occurs when you find that you suddenly owe a tax bill when you have never owed money in the past. Possible reasons for a sudden tax bill include:
• A higher tax bracket. Earning even slightly more money can bump you into a higher tax bracket if you were close to the limit. If you find yourself in a higher tax bracket, your overall liability could increase, leading to a bill in April.
• Changes to the tax code. If the tax code changes and your tax rate increases, you may owe more money than you did in the past, even if your income is the same. Likewise, if credits or deduction you once claimed become unavailable, you may owe money to the IRS when you never have before.
• Loss of a dependent. If you had a dependent child who recently became too old to claim, you will lose all of the tax benefits associated with that child. If you have been receiving these benefits in the past, it is likely that your tax bill will increase substantially.
• Change in filing status. If you changed your filing status, it may impact your tax liability. For example, if you got a divorce and changed your filing status from married filing jointly to single, your tax bill is likely to increase, especially if your spouse earned less income than you.
The Importance of Paying Your Taxes
If you find that you owe taxes to the state or federal government when you file in April, it is only natural to feel upset, especially if the bill is large. However, paying your taxes on time is essential. if you don’t pay your tax bill by its due date, you will face the possibility of interest and other penalties, which will only serve to raise your overall bill. In the worst cases, the IRS or state taxing authority may even take more substantial legal action to collect what you owe. Taxing authorities have a lot more power than other creditors. Not only can they levy your bank account, garnish your paychecks and put liens on your property, but they will also ruin your credit.
Avoiding Future Problems
For some taxpayers, even the best planning won’t be able to avoid a future tax bill. However, if you are careful, you can ensure that any amount you may owe in the future will be as small as possible.
To avoid a future tax bill:
• Make sure your withholding forms have been completed accurately.
• Add extra withholding if necessary.
• Make any estimated tax payments you may owe in a timely manner.
• Pay attention to any tax code changes.
• Plan for the future by anticipated lost dependent credits or other deductions you may no longer qualify to claim.
• File your tax return on time.
• Make sure your tax return is completed accurately and that you have claimed all deductions and credits for which you qualify.
For additional assistance in making sure you are doing everything in your power to avoid a tax bill, consider speaking with a tax professional. A tax professional can help you estimate what you will owe next year, and they can also help you complete all necessary forms accurately.