All About Unexpected Tax Bills
Anyone can incur a significant amount of tax debt to the IRS (Internal Revenue Service). There are risk factors associated with an unexpected tax bill that should be noted and/or avoided. Taxpayers should be aware of these risk factors as they may make them more susceptible to receiving an unexpected tax debt and the associated repercussions that come along with it.
The repercussions include falling into a financial downside that cannot be paid. Failure to pay can lead to a mountain of tax debt; it may even spiral out of control costing a lien on one’s assets or a levy on one’s earnings. This will most likely lead to further stress in an already stressful situation.
To avoid this, taxpayers should be aware of the biggest risk factors for getting unexpected tax bills. They should know the ways to reduce the likelihood of receiving a large tax bill and the things that can be done if they already received one.
The most common circumstances for receiving a costly and unexpected tax bill include being a contract worker, being self-employed or owning a small business. Full-time employees are at risk as well if they are incorrectly completing the withholding amount on their W-4 form or going through considerable changes in financial circumstances.
1. Contract Workers: The Real Deal for Those Flying Solo
Contract workers are individuals retained by a business for a set period. When hiring contract workers, the company is not responsible for deducting taxes from wages earned. This is because contractors do not receive the same benefits that full-time employees do.
Since businesses do not deduct taxes from the paychecks of contract workers, paying taxes is solely the responsibility of the contractors. This makes them the highest risk group that owes money to the IRS, money that they may not have anticipated or had available when due.
Why is it so difficult for contract workers to pay taxes? With contract workers, companies are not required to remind them to “save for tax day.” Contract workers need to save throughout the year so that they can pay the right amount on their taxes when due.
Contract workers should know that they must track their earnings to pay come tax season; that does not mean that they understand how to handle the accounting side of their business. This is especially true for new contractors. This is how they end up owing unexpected taxes that they cannot afford; they just did not account and save for this future tax debt.
So what do they do in tax season? Many may pay with credit cards or personal loans, but most cannot afford to do this or don’t want to. So, they just do not pay the tax bill due. If these workers continue to do this year after year, they will spiral into a wormhole of debt owed to the IRS; this can involve owing penalty fees and interest.
An additional penalty is due if the taxpayer did not pay the estimated quarterly taxes due throughout the year.
What to Do when an additional penalty is due?
To prevent this from happening, contract workers need to prepare for tax season by saving the right amount of money each time they get paid. This means allocating the correct amount and setting it aside throughout the year. It’s advisable to create a separate savings account just for this purpose. That way when taxes are due, the correct amount of money is saved.
Some contract workers also can prepare for taxes by working with an accountant or tax specialist. This should ensure compliance with tax laws and alleviate stress. If an accountant or tax specialist is too expensive, a contact worker may want to invest in an accounting system, especially if they know this type of system.
Another way contract workers can avoid an unexpected bill is to allow spouses to increase the tax withholding if they have a full-time job. This could help even out the amount owed from the contract worker’s jobs. Although this is costly at first, in the end, it is worth it.
By taking one or more of these suggestions, a contract worker may receive a refund when paying taxes if they are accounting and paying correctly throughout the year. The important take away for contract workers is to realize their tax returns are unusual; this means they need to prepare for that by putting aside the correct amount of money each payday.
2. Self-Employed and Small Business Owners: Learning about Additional Taxes
Self-employed individuals or small business owners are just as susceptible to owing unexpected taxes as contract workers. They are at risk because they have the sole responsibility of setting aside the proper amount for the taxes they will need to pay.
Like contractors, unpaid taxes for those doing self-employed work or owning a small business can quickly spiral out of control. This can leave workers with penalties and interest which may evolve into a debt that they will never pay. Some taxpayers are able to pay with credit cards or a personal loan, but most cannot or will not pay this way. Instead, they just do not pay what they owe.
If they continue to do this over the years, the debt will cause further stress and frustration for the taxpayer. It may seem a little upsetting the first year, but as time goes by it will become worse since more and more penalties and interest accrue.
This means that they need to save throughout the year; they need to do this so that they will have the right amount of money to pay the tax they owe. This is not only for annual taxes but also for possible quarterly estimated taxes they need to pay throughout the year.
What to Do to save money on taxes?
Unlike contract workers, self-employed individuals need to pay self-employment tax on top of regular income tax due. If self-employed workers make more than $400 per year, they need to pay self-employment taxes. Self-employment taxes run roughly about 15%.
In paying taxes themselves, self-employed individuals may expect to receive certain deductions; often the deductions do not apply for self-employed taxpayers. This is when a tax professional can help out.
This category of workers is susceptible to audits; certain expenses and/or credits may seem deductible when they are not. Because of this, it’s recommended that those who are self-employed should work with an accountant or tax specialist; these professionals will know the correct tax deductions and payments to pay throughout the year.
If using an accountant or tax specialist is too expensive, they should consider investing in an accounting system. This system is set up to help taxpayers save money throughout the year to pay estimated quarterly taxes and regular annual taxes.
3. Employees Not Withholding the Right Amount on the W-4 Form: A Simple Fix
Regular employees who work full-time may find a large tax debt if they completed their W-4 form incorrectly. Many employees put the wrong amount of withholding on their W-4 form. This means that too little tax is taken out on each paycheck. This means when filing their annual tax return, there is an unforeseen shock in the amount due, especially if they were expecting a refund.
Like contract workers, small business owners, and self-employed individuals, an unexpected tax bill from the IRS can escalate if not taken care of right away. There are penalties for underpaying taxes, other fees may occur, and interest will accrue. Some lean on their credit cards or a personal loan to get out of this jam, while others do not want to or cannot do this.
It’s important to work with the IRS regardless of the amount of debt owed. However, some may decide to not pay at all or work with the IRS, letting years go by, and fees and penalties grow. The amount owed can become quite a significant amount of money. IRS debt can increase over time, leading to a lien on assets or a levy on wages.
Employees or anyone paying taxes should complete their W-4 form correctly. If unsure of the amount to withhold, employees should consult an accountant, tax specialist or even their employer. The most common mistake on the W-4 form is not accounting for major life changes such as marriage and/or a baby.
4. Workers Who Have Had Recent Changes in Financial Circumstances: Changes to Notify the IRS About
Many situations cause taxpayers to undergo financial changes leading to debt. Because of these tricky circumstances, many people end up with tax debt. Taxpayers may not know this, but they are required to report and pay taxes on these circumstances:
• Job loss
• A real estate sale or other applicable assets
• Ownership of rental property
• Large prize or gift (lottery, wedding present, etc.)
This is just a partial list of financial circumstances that taxpayers may not know about. There are other risk factors for receiving an unexpected tax bill and a large amount of tax debt that taxpayers cannot pay; taxpayers should handle these situations with care and pay properly on taxes which usually means setting up a separate savings account. Taxpayers just need to set aside the right amount of taxes.
Otherwise, they can end up owing penalties and fees that can escalate if ignored year after year.
The best way to handle these circumstances is to get advice and help from an accountant or tax specialist. Having a strong accounting program and using it properly throughout the year should help with any confusion regarding taxes. These options should ensure that the taxpayer can pay a large tax bill.
Paying tax debt via credit cards or personal loans is not the best course of action, but it is better than ignoring the IRS. Taxpayers should be upfront with the IRS about their mistakes and any problems with their taxes. Many don’t realize that if years of unpaid taxes go by they can face a lien on their property or a levy on their taxes.