Why do I owe taxes beyond my paycheck withholdings?
Most folks have their tax payments automatically deducted from their paychecks by their employers, but sometimes, a tax bill shows up when they file their return anyway. Here are a few possible reasons why that can happen and what you can do to avoid it.
If you’re a “regular” employee — that is, if you work directly for a company and aren’t an independent contractor or a sole proprietor — odds are you see a significant portion of your paycheck withheld and diverted toward taxes each time you receive your paystub. So, if you get a bill from Uncle Sam after filing your taxes, you may be wondering, what gives? Weren’t all of those automatic paycheck deductions by your employer supposed to cover your taxes for the year?
This situation is actually more common than many think, and it can have a number of causes.
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What are tax withholdings & how do they work? The W-4 explained
Most employees elect to have some of each paycheck withheld automatically by their employer and diverted toward tax payments. These withholdings are usually subdivided into different categories. Federal income, state income Social Security, and Medicare taxes are among the most common.
Exactly how much of each paycheck is withheld by your employer is determined by how you fill out your W-4, an IRS tax form your employer likely gave you when you started your job. Things like filing status (e.g., single, married and filing jointly, head of household, etc.) and income level help your employer estimate your tax burden and determine how much of your paycheck should be withheld for the IRS.
Once it comes time to file, your income and filing status determine how much you owe Uncle Sam, and in many cases, your bill is close to or lower than the total amount withheld from your paychecks over the course of the year. When this is the case, you may not need to pay any additional taxes, and you may even receive a refund from the IRS if your withholdings exceed your tax bill when all is said and done.
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Why don’t my employer deductions cover my tax liability? 3 possible reasons
There are several possible reasons why your paycheck withholdings may not have been sufficient to cover your taxes this year. Here are some of the most common reasons and what you can do to avoid surprises next year.
Your withholdings were too low
One of the most common reasons you may owe more than was withheld by your employer is that your withholdings, as established through the W-4 you filed with your employer, were too low.
Perhaps you elected lower withholdings so that less money would be taken out of your paychecks. This is a perfectly acceptable thing to do, and it allows you to avoid loaning your hard-earned money to the IRS interest-free throughout the year. That being said, this practice results in most or all of your tax being due when you file, which can be a significant financial burden if you haven’t planned for it.
So, if you’d rather not pay in a lump sum, increasing your withholdings to match your estimated tax liability essentially spreads your tax payments across the year so that no one payment is too large. You can do this by submitting an updated W-4 to your employer at any time.
Your pay increased but your withholdings did not
Another possible reason you might owe additional taxes beyond your withholdings is that your pay increased at some point during the year, but your withholdings did not. In some cases, a pay raise can even bump you up into a higher tax bracket.
Any time your pay increases, your tax liability is likely to increase as well, so if your employer’s paycheck deductions remain the same, it’s not at all unlikely that you might owe the IRS some money when you file your tax return.
To avoid this, be sure to submit a new W-4 as soon as your raise kicks in.
You received additional income that wasn’t subject to withholding
Another common reason you might owe taxes — even if you filled out your W-4 so that your employer withholdings should have matched your tax liability based on your pay — is that you didn’t account for additional income received from sources other than your primary employer.
Perhaps you earn income from a hobby business or “side hustle” (like selling crafts or garments online). Maybe you received a lump sum of money from an inheritance, or received income in the form of capital gains by selling one or more securities that had skyrocketed in value. Unemployment and Social Security benefits are also taxable, and many people forget to account for these types of income when filling out their W-4.
The best way to avoid this in the future is to submit a new W-4 every year and account for all expected income when you fill it out. If anything changes over the course of the year, submitting a revised W-4 that accounts for unexpected income (or unexpected reductions in income) can help you avoid any surprises come tax time.
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How to make sure that you don’t owe taxes: IRS online tax withholding estimator
The absolute best way to avoid unexpectedly owing taxes when you file is to make sure your employer withholdings are accurate by updating your W-4 whenever necessary and accounting for any additional taxable income by using the IRS’ online tax withholding estimator tool. This tool can help you decide how to fill out your W-4 and account for income received outside of your primary employer.
The tool is fairly straightforward to use. Simply select your filing status, and enter basic information such as whether your employer withholds tax payments on your behalf and whether you receive pension payments.
Walk through the tool’s questions one at a time, being sure to provide all relevant information, and the tool will let you know how much income you might need to withhold for taxes outside of your employer’s withholdings and direct you to additional forms you may be able to fill out in order to automate these withholdings.
For example, Form W-4V allows you to voluntarily automate withholdings from Social Security and unemployment benefits, and Form W-4P allows you to voluntarily automate withholdings from annuity and pension income.
When it comes to self-employment income, capital gains, cash gifts, inheritances, and other sorts of income, you may need to account for your withholdings yourself, but the tool can help you decide how much to put away for taxes.
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