If you pay taxes, you are a part of the majority. The IRS predicts 168 million Americans will file tax returns in 2023. An estimated two-thirds of tax returns filed will show taxable income. You’re likely to owe taxes, but knowing why you owe taxes can help you minimize your tax bill in future years. This guide will walk you through some of the common reasons people owe taxes.
9 Most Common Reasons to Owe Taxes
People owe taxes for many reasons. These are some of the most common reasons people end up paying taxes.
Insufficient Tax Withholding
Some people pay less than the required taxes and can receive penalties for paying too little. Insufficient tax withholding occurs when there isn’t enough money withheld from your paycheck for tax purposes. You can make small tax payments quarterly to minimize the likelihood of incurring insufficient tax withholding. This strategy also helps break up the final bill.
Changes in Income or Employment
Earning more income can move you to a higher tax bracket and result in a higher bill. The IRS adjusts tax brackets each year. If you pick up an extra side hustle and earn an extra $20,000 per year, your money will get taxed at a higher rate. You can lower your taxes if you legally reduce your taxable income with deductions and traditional retirement account contributions.
Decrease in Deductions or Credits
Deductions and credits minimize your total taxes. Business owners can capitalize on business expenses and use them as write-offs. Consumers can also take advantage of several credits, such as education and child tax credits. If you can’t capitalize on as many deductions or credits the following tax year, you may end up with a higher bill.
Changes in Tax Laws
Tax laws can change at any time and impact your tax liability. Changes to tax brackets and the standard deduction are some of the tax laws that influence how much you pay in April.
Underestimated Estimated Tax Payments
Estimated tax payments help you stay ahead of the curve and ensure your taxes get paid in a timely manner. But it is possible to underestimate these payments and end up underpaying. Paying less than your fair share can result in penalties. The IRS makes it easier to calculate your estimated tax payments through Form 1040-ES.
Unreported Income or Incorrect Tax Filing
Any errors or unreported income can result in penalties and increase how much you owe in taxes. Working with an accountant to file your taxes can ensure there aren’t any mistakes. Having a professional handle your tax returns can save you a lot of time and money. Some accountants let you know about some of the tax deductions and credits you can use to lower your tax bill.
Inadequate Tax Planning
Inadequate tax planning can increase how much you owe in taxes. If you do not save money leading up to tax day, you may not have enough funds to pay your tax bill on time. Allocating 10% to 20% of every paycheck to a separate bank account for your taxes will leave you better prepared. You should predict your income and look at tax brackets to assess how much of each paycheck to put in this account. Putting the money into a high-yield savings account allows you to accumulate interest leading up to tax day.
Investment Gains
If you sold investments and have a net capital gain, you will owe taxes on those proceeds. You will also owe taxes on any dividend payments. Significant capital gains can result in a higher tax bill than usual. Some investors use tax-loss harvesting to minimize their capital gains.
Early Withdrawals From Retirement Accounts
Withdrawals from a traditional retirement account get taxed at the ordinary income rate. These withdrawals will increase how much you owe in taxes, especially if you withdraw before the eligible age. Withdrawals from a Roth retirement account do not get taxed.
Keeping Up with Taxes
Many people pay taxes every year, but understanding what triggers taxes can help you minimize your tax bill. Saving money and planning for the tax season can help you make on-time payments and avoid penalties.
Frequently Asked Questions
When do you owe taxes?
You owe taxes on tax day in April, but you can make smaller tax payments throughout the year to minimize the April tax bill.
Why am I paying taxes this year?
You may be paying taxes because of your taxable income, capital gains and other reasons.
Why would I owe taxes?
You would owe taxes if you have taxable income, capital gains and for other reasons.