The Top 6 Reasons You’re Going To Owe Money In Taxes This Year
Although some of us look forward to a tax refund each spring, many of us are going to get an unpleasant “balance due” surprise after we file taxes.
According to the IRS, 18.6 million individual Americans reportedly owed the agency a combined $360 billion in overdue taxes in 2022. Ideally, you should not be getting a large bill or a big check from the IRS.
“The goal with taxes is to not overpay or underpay,” said Tiffany Watson, the CEO of All Aboard Financial, a virtual accounting and financial consulting firm based in Tampa, Florida. “So if you can, you tweak it so that you can get it just right where you don’t expect anything back or you’re not paying the IRS ––That’s the sweet spot.”
You don’t want to be caught off-guard with a hefty bill after filing ― especially with no understanding of why. Here are the most common reasons people may owe money to the IRS after filing taxes this year:
1. You didn’t adjust your withholdings after a major life change.
The most common reason why taxpayers end up owing money to the IRS is because they did not have enough money taken out of their paychecks throughout the year, according to tax experts.
When employees first start a job, they fill out a W-4 form, which determines how much money is withheld from their paychecks for taxes. But you are supposed to update your W-4 after every major life change like marriage, divorce, the loss of a spouse, the birth or adoption of a child, a new home, or getting a second job, because those life events can immediately impact the taxes you’ll owe.
“What I usually see is that people just don’t make adjustments. They do it that one time, and then it’s like ‘out of sight, out of mind.’ But whenever you have a life change, you should be adjusting your W-4 at your employer,” Watson said.
The IRS has an online Tax Withholding Estimator that can help you estimate if you need to change your withholding with your employer. If you determine that you need to do so, you can do this by submitting a revised W-4 to your company.
2. You didn’t pay self-employment taxes.
Did you start a business or pick up side gigs last year? If you earned more than $400 during the year as a self-employed individual, you are supposed to be paying self-employment taxes throughout the year.
Minnie Sage, the program director of Tax-Aid, a nonprofit that provides free tax services to the San Francisco Bay Area, said a big confusion for new gig workers doing DoorDash or Uber is them not understanding that they are classified as self-employed workers by the government.
“They just don’t know the ins and outs,” she said. “They don’t know that they have to pay quarterly taxes,” she said. But if you’re self-employed and you don’t pay taxes in quarterly estimates, you’re going to get an expensive surprise from the IRS in the spring.
“For some reason, they don’t take out the tax, they don’t set anything aside,” Watson said. “I always recommend, especially for my self-employed individuals, to have a separate savings account … where you set money aside to pay your taxes, because if not, they’re going to be hit with a large tax bill at the end of the year.”
If you didn’t get your math right, you may end up with an underpayment penalty you’ll need to pay in addition to your self-employment taxes.
3. You didn’t pay a capital gains tax.
When you make a profit from selling a home, a car, stocks, cryptocurrency or other investments, those assets are taxable income.
Your overall taxable income helps to determine how much your capital gains tax will be. “For taxable years beginning in 2023, the tax rate on most net capital gain is no higher than 15% for most individuals,” according to the IRS’s website.
Mark Steber, chief tax information officer for tax-preparation service Jackson Hewitt, said the rise of virtual currency, the legalization of sports betting in more states, and the availability of more income opportunities are some of the reasons people end up owing more money after filing taxes.
“More other sources of income without automatic withholding … has led to a surge of ‘balance-due’ filers,” he said.
Watson said one other common scenario is when people do not realize the sale of their home is now subject to a capital gains tax. “‘Yippee, we sold this,’ and then next thing, you know, it’s like, ‘Oh, by the way, you owe $16,000,’” Watson said.
If you’re thinking of selling property, Watson advises talking with a tax professional to help you determine if you’re eligible for deductions and credits that could help you offset the capital gains tax.
4. You got unemployment benefits.
In the last year, there were many mass layoffs, and if you collected unemployment benefits after you lost your job, that unemployment income is taxable at the federal level and in most states.
When you go apply for unemployment benefits at your state’s Department of Labor, Steber said you will be asked if you want to have taxes withheld from your payments, and “99 times out of 100, people do not have taxes withheld from their unemployment benefits, even though it’s kind of a best practice.“
Steber noted the reality that unemployment benefits are “100%, taxable, non- excludable” often “catches people off guard.”
5. You withdrew money from your retirement account.
In 2020, the CARES Act relaxed penalties for withdrawing money from retirement accounts because of hardship, but those penalties are back in place. Watson said she’s seen taxpayers who are caught off-guard by having to pay an additional 10% tax.
“Usually, if you’re under 59-and-a-half, you are expected to pay that 10% penalty,” Watson said.
6. You took too many deductions.
Tax deductions get subtracted from your total taxable income and can significantly reduce the taxes you owe, but be careful about what you write off, because you may need to back up your reasoning for business expenses related to depreciable assets like a luxury vehicle.
“A lot of people think that just because you’ve filed your taxes, you’ve gotten your refund and everything, you’re in the clear. You’re not. The IRS can actually go back and review a couple of years prior,” Watson said.
Watson gave the example of an accountant who does not need to drive for their job and writes off their luxury Mercedes G-Wagen car purchase for their taxes. The IRS could then audit this accountant because they don’t have the appropriate data to support why this asset was depreciated for this type of business.
“What the IRS can do is take away the depreciation, take away the deduction for you, and then you end up owing taxes,” Watson said. So don’t just write off everything as a business expense, especially if you work for yourself.
“I see a lot of mistakes made with self-employment from taking too many deductions,” Steber said. “Because you don’t get to take your home mortgage, you don’t get to take your utilities, you don’t get to take some things.”
Steber said going to a tax professional can help you see what deductions you qualify for and what you do not. “I believe in [being] accurate, but also believe in taking every dollar that you are allowed under the law,” he said.
Expect to owe taxes? Here’s what to know.
The tax filing deadline is this April 15, but you should be preparing much sooner ― especially if you’re expecting to owe money. Here are steps you can take now:
Talk to a professional sooner rather than later.
Nearly 1 in 3 taxpayers say they are dreading the process of filing their taxes, according to a January survey of 3,000 U.S. adults by Intuit Credit Karma.
But once you prepare all your documents, seeking professional tax help sooner will help you avoid working “against the midnight hour” on April 15 if you need additional documentation, Steber said.
Once you work with a professional, “you know what you’re dealing with and if you need to go back and get some records on that home office and some of those other expenses that you really didn’t think were deductible, but once you talk to a pro they are,” Steber said as an example.
And when you go to your tax professional, it will help if you give them detailed documents of all of your earnings activity, so you know exactly what to claim.
“Keep good records on all of your activity. Not just your W-2s and your 1099s, but if you’ve got a side hustle, you need to keep good records of what you earned,” Steber said.
Review your options for paying.
Ideally, paying your tax bill in full and on time is your best option because it avoids future penalties or interest added.
But if that’s not possible, you can apply for a short-term extension with the IRS of up to 180 days, or a long-term installment plan with the IRS, depending on how much you owe and how soon you can pay the balance.
Build up an emergency fund for unexpected tax bills.
And to avoid sticker shock in the future, start setting up a savings account just for potential taxes you may owe, Watson suggested.
“Anytime you are doing something where there are no taxes being withheld, but you’re being paid, you should be setting aside money for your taxes,” Watson said.