When you earn money, the government has a set amount it expects you to pay in taxes. If you don’t pay enough throughout the year, you’ll owe taxes when you file your taxes. There are many reasons why you might owe taxes. For example, if you earn a lot of money, you’ll likely owe more taxes. Additionally, if you have a lot of deductions and credits, you’ll likely owe less taxes. Owing taxes can be a hassle, but it’s important to take care of it as soon as possible. If you don’t, you could face penalties and interest charges.
How to Avoid Owing Taxes
There are a few reasons why you might owe taxes. One common reason is that your income exceeds your allowances. Allowances are deductions that reduce your taxable income. The more allowances you claim, the lower your taxable income will be. However, if you claim too many allowances, you may end up owing taxes.
Income Exceeding Allowances
If your income exceeds your allowances, you will owe taxes on the excess income. For example, if you earn $50,000 and claim 2 allowances, your taxable income will be $44,000. However, if you only earn $40,000, you will not owe any taxes.
There are a few ways to avoid owing taxes if your income exceeds your allowances. One way is to increase your withholding. Withholding is the amount of money that is taken out of your paycheck for taxes. You can increase your withholding by submitting a new W-4 form to your employer.
Another way to avoid owing taxes is to make estimated tax payments. Estimated tax payments are payments that you make to the IRS throughout the year. These payments are based on your expected tax liability for the year. If you make estimated tax payments, you will not owe any taxes when you file your tax return.
If you do end up owing taxes, you will need to pay them when you file your tax return. You can pay your taxes online, by mail, or by phone. If you cannot pay your taxes in full, you may be able to set up an installment plan with the IRS.
Here is a table that summarizes the different ways to avoid owing taxes:
| Method | Description |
|---|---|
| Increase your withholding | Submit a new W-4 form to your employer. |
| Make estimated tax payments | Make payments to the IRS throughout the year. |
| Pay your taxes in full | Pay your taxes when you file your tax return. |
| Set up an installment plan | Make payments to the IRS over time. |
Self-Employment Without Estimated Tax Payments
Self-employed individuals are responsible for paying estimated taxes throughout the year, similar to employees who have taxes withheld from their paychecks. If you have not been making estimated tax payments or have underpaid your estimated taxes, you may end up owing taxes when you file your annual tax return.
Here are some reasons why self-employed individuals without estimated tax payments may owe taxes:
- Underestimating Income: Self-employed individuals often underestimate their income for the year, leading to underpayment of estimated taxes.
- Unexpected Deductions: Unexpected or unforeseen deductions can reduce taxable income, resulting in lower estimated tax payments.
- Large Quarterly Payments: Estimated tax payments are due quarterly, and if the self-employed individual has uneven income distribution, they may have large quarterly payments that exceed their actual income.
To avoid owing taxes as a self-employed individual, it is important to:
- Accurately Estimate Income: Use previous tax returns, financial statements, and income projections to estimate your yearly income as accurately as possible.
- Consider Large Deductions: If you anticipate large deductions, such as business expenses or retirement contributions, adjust your estimated tax payments accordingly.
- Make Quarterly Payments: Make estimated tax payments on time and in sufficient amounts to cover your tax liability.
- Consider Self-Employment Tax: Self-employed individuals are responsible for paying both the employee and employer portions of Social Security and Medicare taxes, so factor this into your estimated tax payments.
The table below provides a summary of the consequences of underpaying estimated taxes:
| Underpayment Amount | Penalty |
|---|---|
| Less than 10% of tax liability | No penalty if tax liability is less than $1,000 |
| 10% – 45% of tax liability | Penalty equal to a percentage of the underpayment |
| More than 45% of tax liability | Penalty equal to 100% of the unpaid taxes |
Investment Gains and Losses
When you sell an investment, such as a stock or bond, you may have to pay taxes on the gain you made. The amount of tax you owe will depend on the type of investment, the length of time you held it, and your income tax bracket. Short-term capital gains are taxed at your ordinary income tax rate. Long-term capital gains are taxed at a lower rate, which is 0%, 15%, or 20%, depending on your income.
If you sell an investment at a loss, you may be able to deduct the loss from your taxes. However, there are limits on how much you can deduct. You can only deduct up to $3,000 of capital losses per year. If you have more than $3,000 in capital losses, you can carry the losses forward to future years.
| Income Bracket | Tax Rate |
|---|---|
| 0-15% | 0% |
| 15-39.6% | 15% |
| 39.6-43.4% | 20% |
Earned Income Tax Credit Disqualification
The Earned Income Tax Credit (EITC) is a tax credit for low- and moderate-income working individuals and families. To be eligible for the EITC, you must meet certain requirements, including having earned income and filing a tax return. If you do not meet the requirements, you may be disqualified from receiving the EITC.
Some of the reasons why you may be disqualified from receiving the EITC include:
- You have investment income that is more than $4,000.
- Your filing status is married filing separately and you lived with your spouse at any time during the year.
- You are a nonresident alien.
- You claimed the EITC in a prior year and did not repay the credit.
If you are disqualified from receiving the EITC, you may still be able to claim other tax credits or deductions. You should consult with a tax professional to determine your eligibility.