Tax Questions & Tips

Why do I owe taxes?

December 1st, 2022 Dec 1, 2022 • Read time: 7 min

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Wondering why you owe taxes this year? There can be many factors that play a role. Put simply though, the main reason that you owe taxes at the end of the year is because you did not pay enough taxes over the course of the year. This tax bill can often be a result of not having enough money withheld from your paycheck. If a proper amount of tax money isn’t withheld, you will need to pay back the difference at the end of the year. Let’s take a deeper look at tax withholding and the situations where you may end up owing taxes.

What is withholding tax?

Withholding tax is the portion of your total wages that your employer deducts from your pay each pay period and sends directly to the government. This “withheld” amount is meant to cover some or all of your tax responsibilities for the year. Almost all employees in the US are required to participate in the tax withholding system and must pay income tax. Part of this withheld income tax money is sent to the IRS, which is a federal government agency. The other part is usually sent to the government of the state that you live in. However, there are nine states that don’t have state income taxes – if you live in one of these states, you will still have taxes withheld for federal income taxes, but not for state income taxes. 

The states that don’t have state income taxes are:

  • Florida
  • Alaska
  • Wyoming
  • Nevada
  • Tennessee
  • South Dakota
  • Texas
  • New Hampshire (*Except for taxes on investment income and dividends)
  • Washington (*Unless you have made large amounts of money on investments like stocks and bonds)

Why do I owe taxes this year?

When doing your taxes, it’s common to look at the numbers and wonder “Why do I owe taxes this year and not last year?” There are many things that can contribute to owing more taxes or having a high tax bill, and it can sometimes be complicated to figure out the causes. Here are some typical issues to look into.

Employment changes

If you’ve changed jobs this year, it can affect how much tax was withheld from your paychecks. When you begin a new job, your employer will usually have you fill out a W-4 form. A W-4 is also known as an “Employee’s Withholding Allowance Certificate” – basically, it is a form used to calculate how much of your wages should be withheld to pay income tax. A W-4 requires that you fill out a number of different pieces of information including your filing status, your dependents, and any deductions or tax credits that you believe you qualify for. 

Because a W-4 is a complex document, it is possible to fill it out incorrectly. If it is not filled out properly, you may end up paying too little or too much in income tax over the course of the year. When you go to file your taxes, this mistake on the W-4 will need to be balanced out – resulting in either a tax debt or a tax refund. So, if you have filled out a new W-4 this year, it’s possible that it contained an error that has changed how much tax was withheld compared to your previous job. 

Child Tax Credit

The Child Tax Credit is a type of tax credit that is available to some parents if they have children that they can claim as dependents. It is designed to help parents pay for the extra expenses that come with having children. The payment amount for this tax credit can change each year based on your situation, and also based on changes that the government might make to qualification requirements. 

If you have made more money this year than you have in past years, you may qualify for less of a tax credit. Or, if the IRS has lowered the maximum income level that qualifies for the Child Tax Credit, your income may now be too high to qualify – even if your income hasn’t increased since last year. If you have received more money from the Child Tax Credit than you were supposed to, the IRS will want this money sent back when you file your taxes.

Income from self-employment 

If you have become self-employed over the past year or have taken on a self-employed side job, you may owe more taxes than you did last year. There are many different forms of self-employment. From a tax perspective, most contract jobs, freelance work, and side hustles count as self-employment. This usually includes things like driving for a ride sharing or food delivery service, dog walking service, short-term childcare service, selling a very high volume of goods on the resale market (think Facebook Marketplace or CraigsList), or other types of “gig” work. 

When you are employed by a traditional employer, they are responsible for a portion of your tax burden. When they withhold a portion of your pay and send it to the government, they also pay a portion themselves. However, when you are self-employed, you are responsible for paying the full amount yourself. This means that if you are self-employed, you will pay a larger amount of money in tax than you would if you were traditionally employed. 

The government expects self-employed people to pay their taxes on a regular basis. The rule is that if you are on track to owe more than $1,000 in taxes for the year, you are supposed to make estimated quarterly tax payments. This way you pay approximately the amount that you owe over the course of the year. If you don’t make these quarterly payments, you will still owe all taxes at the end of the year. And you may also have to pay penalties for failing to make quarterly payments.

Capital gains taxes

Capital gains tax is relevant if you have investments such as stocks, bonds, NFTs, cryptocurrencies, real estate, or jewelry. Whenever you sell one of these types of investments, the capital gains tax will be applied to the profit that you make from the sale. 

Capital gains tax is divided into long-term and short-term profits. For instance, if you buy a stock and then sell it within a year of original purchase, you will pay short-term capital gains tax on it. This means that profit will be taxed at the same rate as other more traditional earned income on your taxes. If you buy a stock and then sell it more than a year after the date when you purchased it, you will pay long-term capital gains tax on it. The amount of long-term capital gains tax you will pay depends on your total income and can vary from 0% to 20%. All gains from stocks and cryptocurrency have to be reported to the IRS. If you haven’t accounted for capital gains tax, you may be surprised by the tax amount that you owe when you go to pay your taxes.

Fewer tax deductions

Tax deductions allow you to reduce the amount of your income that is considered taxable. If you qualify for deductions, they can decrease how much you will owe in taxes. Common deductions include the Child Tax Credit, earned income tax credit, medical expenses deduction, and student loan interest deduction – but there are many, many more. While these deductions can be helpful, you may qualify for a certain deduction one year, and then not qualify for that same deduction the next year. If you have less deductions available to you this year, it’s possible that you will have a higher tax burden than in previous years.

What to do if you owe taxes

If you owe money on your taxes, that money is due on tax day, which typically falls on Apil 15th — though you will want to check the specific day in the year you are filing. If you can’t afford to pay the money right away, you can file for an extension on your taxes. If your extension is approved, you can delay filing your taxes for several months until you have the necessary funds to pay your tax bill. If you aren’t able to pay your entire tax bill at the time of filing, you have some options:

  • Apply for an IRS payment plan – if you’re approved, this will allow you to either pay back the full owed tax amount in a lump sum within 120 days, or pay back smaller amounts over a longer period of time
  • Apply for an offer in compromise – if you gain approval, this allows you to settle your tax bill for less than the full amount that you owe
  •  Apply for a loan and use that money to pay off your tax bill

Each option comes with its own advantages and disadvantages – the best choice will vary based on your personal situation.

How to avoid owing taxes 

The best way to avoid owing taxes is to be proactive and stay aware of changes over the course of the year that might affect your tax burden:

  • Carefully fill out your W-4 forms and update them whenever your tax situation changes
  • Estimate your tax withholding ahead of time to have a sense of how much you will owe – this IRS calculator can help you prepare
  • Talk with a tax professional to make sure you are receiving all the deductions that you qualify for

Work with tax experts 

While there are many reasons why you may owe taxes, there are also many ways that you can reduce the amount that you owe. With over two decades of tax preparation experience, our tax professionals can help you with the filing process and provide peace of mind. Learn more about Sun Loan’s tax prep services and get filing today!

Author – Doug Flach

Doug Flach is a partner at Accurate Tax Solutions, a tax preparation firm based out of Alpharetta, GA. Doug’s resume boasts over two decades in the tax industry with a specialization in tax return p... Read more »

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