Nobody loves a surprise tax bill. Even worse is owing the IRS every year, despite making changes to your withholdings.
If that sounds familiar, you’ll be interested to know about the five most common reasons you always owe taxes — and the steps you can take to ensure a refund next year.
Not Enough Withheld on Your Paychecks. The main reason people never get a tax refund is simple: They don’t withhold enough cash from their paycheck. That being said, while it’s tempting to claim nine withholding deductions for a couple of pay periods to get through a tough time financially, doing so can set you up for a large year-end bill from the IRS if you’re not careful. You can find a free W-4 calculator online that can help you estimate how claiming different withholdings can impact your overall tax burden.
Ignoring Life Changes. It’s important to account for changes in your life. For example, if you no longer are required to pay alimony, you got a boost in your personal net income but no longer receive any tax deduction for your payments. Losing dependents is another biggie. When the kids leave the nest, parents need to reconfigure their withholdings to account for the fact they no longer can use the child dependent deductions.
No Withholdings for Extra Income. Did you earn extra income this past year for which there were no withholdings? For instance, maybe you realized some investment profits. Perhaps, you received unemployment checks.
Not Paying Self-Employment Tax. Owning your own business is awesome, except during tax time. Self-employment taxes are usually much more complicated and time-consuming than it is for employees, who simply just enter their W2 information.For this reason, many business owners put off paying self-employment tax which can come back to bite them at tax time.
Not Filing Quarterly Estimated Taxes. Non-wage income earners who make a significant amount should make quarterly estimated payments; but for many, that’s a considerable task. As painful as it is, the price of owning a successful business is doing quarterly tax estimates to keep you out of trouble at year’s end.
How to Ensure You’ll Get a Refund Next Year
The good news is, with a little planning, you can make sure you have an income tax refund every year. Paying the right amount of taxes throughout the year not only ensures you won’t owe additional taxes at tax time, but it also eliminates the possibility of fines, interest or worse: IRS recovery tactics such as tax levies.
Determine Your Tax Liability. The first step is to figure out how much money should be going to the IRS each year based on your income. Filling out a sample IRS tax return is probably the most accurate way to determine your tax liability. Fill out a 1040 form, either manually or by using tax software. By completing a sample tax return, you can see if you presently owe and adjust your paycheck withholdings for the rest of the year to make sure you are paying enough.
Online paycheck calculators are another way to determine your tax liability. They’re fast and reasonably reliable — but not pinpoint-accurate. That’s because they don’t know which tax credits you’ll claim, and if you’re itemizing or using the standard deduction.
The IRS tax withholding calculator is the best option for those with more complicated taxes. This tool will ask you a number of detailed questions pertaining to child and dependent care tax credits. It will also ask for your retirement plan or health savings account (HSA) contributions. Of course, the calculator also factors in the taxes you pay on your paycheck each week. Once you complete the questions, the calculator will reveal how much tax you’ll likely owe at year end. It will also reveal how much you’ve paid already, and your estimated tax bill or refund.
Figure Out Your Tax Withholding. Once you know your estimated tax liability, then all you have to do is determine how much you need to withhold from your paycheck each pay period to reach that total by the end of the year. If you’re not paying enough federal tax each pay period, the simplest way to resolve the issue is to fill out a new W-4. Then enter the additional amount you want to pay on Line 6.
Make Sure You’re on Track for the Year. In a perfect world, you’ll know your tax liability in the first week of the year. To ensure you’re on track, divide your total tax liability by the number of paychecks you’ll receive throughout the year. Once you receive your first paycheck, compare it to what you should be paying. Then make appropriate changes to your W-4. Just remember, if you’re doing this exercise at any point after that first paycheck, then you have to account for the previous paychecks when you weren’t paying enough, or paying too much.
The Bottom Line
If you want a refund next year, it’s important to make sure you’re avoid the five mistakes listed above. Then, take stock of where you are by figuring out how much you have already paid in federal taxes. Compare that amount by how much you should pay to meet your estimated tax liability for the year. After that, it’s just a matter of making the appropriate adjustments on your W-4 form.
Photo Credits: stock photo
We have nothing withheld and pay estimated quarterly taxes, using projected income/deductions to estimate the current year’s tax liability. This way, WE get use of our money during the year instead of the Feds having it. So far, so good. 🙂
Smart! 🙂
For people who have trouble saving, and considering the abysmal rate paid on savings, having extra withholding taken from you check is a good way to insure that once a year you have a lump of money given back to you. If you’re smart you won’t blow the cash but instead pay off credit card or other debt or establish an emergency fund.