While some anticipate receiving a
tax refund every spring, others may face an unpleasant surprise of owing taxes
after filing.
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| These common mistakes will leave you with an expensive surprise from the IRS in the spring |
In 2022, the IRS reported that 18.6 million individual Americans collectively owed $360 billion in overdue taxes. Ideally, you should aim to neither owe a large sum nor receive a substantial refund from the IRS.
Tiffany Watson, CEO of All Aboard
Financial, a virtual accounting and financial consulting firm in Tampa,
Florida, emphasized the importance of balancing taxes to avoid overpaying or
underpaying. Achieving this balance ensures you neither expect a refund nor owe
the IRS.
It's crucial to avoid being blindsided by a significant tax bill after filing, especially without understanding why it occurred. Here are the primary reasons people might owe money to the IRS after filing taxes this year:
1. You didn’t adjust your
withholdings after a major life change
The primary reason taxpayers find
themselves owing money to the IRS is due to inadequate withholding from their
paychecks throughout the year, as stated by tax experts.
When individuals begin employment,
they complete a W-4 form, dictating the amount withheld from their pay for
taxes. However, it's essential to update the W-4 after significant life events
such as marriage, divorce, the death of a spouse, the birth or adoption of a
child, purchasing a new home, or acquiring a second job. These events can
immediately impact your tax obligations.
"People often fail to make adjustments. They fill it out once and forget
about it. But whenever there's a significant life change, you should update
your W-4 with your employer," said Watson.
The IRS provides an online Tax Withholding Estimator to help individuals determine if they need to adjust their withholding. If necessary, you can submit a revised W-4 to your employer.
2. You didn’t pay self-employment
taxes
Did you venture into
entrepreneurship or take on side jobs last year? If your earnings as a
self-employed individual exceeded $400 during the year, you're required to pay
self-employment taxes regularly.
Minnie Sage, program director of
Tax-Aid, a nonprofit offering free tax services in the San Francisco Bay Area,
noted a common confusion among new gig workers for platforms like DoorDash or
Uber regarding their classification as self-employed by the government.
"They often lack understanding of the process," she said.
"They're unaware of the requirement
to pay quarterly taxes." However, failure to do so as a self-employed
individual can result in a significant tax bill from the IRS come spring.
"Many neglect to set aside taxes or make quarterly payments,"
Watson explained. "I always advise
my self-employed clients to establish a separate savings account dedicated to
tax payments. Otherwise, they risk facing a hefty tax bill later on."
Miscalculations could lead to underpayment penalties in addition to self-employment taxes owed.
3. You didn’t pay a capital gains
tax
When you generate profit from the
sale of assets such as a home, car, stocks, cryptocurrency, or other
investments, those gains are considered taxable income.
The capital gains tax you owe is
determined by your overall taxable income. "For taxable years starting in 2023, the tax rate on most net capital
gains is generally capped at 15% for most individuals," states the IRS
website.
Mark Steber, chief tax information
officer at Jackson Hewitt, pointed out that the increase in virtual currency
usage, the legalization of sports betting in more states, and the availability
of additional income opportunities contribute to more individuals owing taxes
after filing.
"Additional sources of income without automatic withholding have led to
a rise in taxpayers owing money," he explained.
Watson highlighted another common
scenario where individuals are unaware that the sale of their home is subject
to capital gains tax. "People often
celebrate selling their home, only to realize they owe a significant tax bill
afterward," Watson said.
If you're considering selling property, Watson recommends consulting with a tax professional to determine eligibility for deductions and credits that could help offset the capital gains tax.
4. You got unemployment benefits
During the past year, there were
numerous mass layoffs, and if you received unemployment benefits following job
loss, that income is subject to federal taxation and taxation in most states.
When you apply for unemployment
benefits through your state's Department of Labor, Steber explained that you'll
be asked if you want taxes withheld from your payments. "In most cases, people opt not to have taxes
withheld from their unemployment benefits, despite it being a recommended
practice," he said.
Steber highlighted the common surprise among individuals that unemployment benefits are fully taxable and cannot be excluded from taxation.
5. You withdrew money from your
retirement account
In 2020, the CARES Act temporarily
eased penalties for withdrawing funds from retirement accounts due to hardship,
but those penalties have since been reinstated. Watson mentioned encountering
taxpayers who are surprised by the requirement to pay an additional 10% tax.
"Typically, individuals under the age of 59-and-a-half are subject to paying that 10% penalty," Watson explained.
6. You took too many deductions
Tax deductions are subtracted from
your total taxable income and can significantly reduce your tax liability.
However, it's essential to be cautious about what you claim as deductions,
particularly for business expenses related to depreciable assets such as luxury
vehicles.
"People often assume that once they've filed their taxes and received
their refund, they're in the clear. That's not always the case. The IRS has the
authority to review returns from previous years," Watson warned.
Watson illustrated this with an example of an accountant who doesn't require a luxury car for work but claims the purchase of a Mercedes G-Wagen as a business expense on their taxes. In such cases, the IRS might audit the individual due to insufficient evidence supporting the depreciation of the asset for business purposes.
"The IRS can disallow the depreciation and deduction, resulting in owed
taxes," Watson explained. Therefore, it's crucial not to
indiscriminately write off expenses as business-related, especially for
self-employed individuals.
"I often see errors in self-employment taxes due to excessive
deductions," Steber added. "You
can't deduct home mortgages or utilities when you're self-employed."
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| If you're worried about owing money this year, get a professional's help. They can help you see if there are any deductions you qualify for |
Consulting a tax professional can help identify eligible deductions and avoid improper claims. "I believe in accuracy while maximizing deductions within the bounds of the law," Steber concluded.
Expect to owe taxes? Here’s what to
know
The deadline for filing taxes falls
on April 15th, but it's advisable to start preparing well in advance,
particularly if you anticipate owing money. Here are some steps you can take
now:
Talk to a professional sooner
rather than later
Nearly one-third of taxpayers express dread about the tax filing process, according to a January survey of 3,000 U.S. adults conducted by Intuit Credit Karma.
Once you've gathered all your
necessary documents, seeking professional tax assistance early can prevent a
last-minute scramble on April 15th for additional documentation, advises
Steber.
Engaging with a professional allows
you to understand your tax situation better. For instance, Steber mentioned
that consulting a professional might reveal deductible expenses like those
related to a home office, which you might not have initially considered.
Providing detailed documentation of all your earnings activities when consulting with a tax professional is beneficial. "Maintain comprehensive records of all your activities, not just your W-2s and 1099s. If you have a side hustle, ensure you keep detailed records of your earnings," Steber emphasized.
Review your options for paying
The optimal scenario is to pay your
tax bill in its entirety and by the deadline, as this prevents the addition of
future penalties or interest.
However, if paying in full isn't feasible, you have alternatives. You can request a short-term extension from the IRS, which can extend up to 180 days, or opt for a long-term installment plan depending on the amount owed and your ability to pay off the balance promptly.
Build up an emergency fund for
unexpected tax bills
To prevent future financial
surprises, Watson recommends establishing a dedicated savings account
specifically for potential tax obligations.
"Whenever you're earning income without taxes being withheld, it's
essential to set aside funds for taxes," Watson advised.
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