“The guy who said that the truth never hurts never had to fill out a 2210 tax form.” (Unknown)
What’s worse than doing your taxes? Realizing that you need to pay more than you thought!
As we mentioned in 5 Smart Ways To Use Your Tax Refund, more than 1 out of 3 Americans gets a tax refund. However, and especially if you make over $200,000 a year, some taxpayers get the nasty surprise of a tax bill instead of a check in the mail. In some cases, this bill can be thousands of dollars – dollars you didn’t budget for. To top it all off, you have to pay a penalty to the IRS if you owe more than $1,000, if you paid less than 90% of the tax for the current year, or if you paid less than 100% of the tax shown on the return for the prior year.
So what are the usual suspects when it comes to getting a bill rather than a refund check? The two main culprits are one-time events and increasing income.
A unique windfall event like a large capital gain from a property sale can be a trigger. A common instance here is when you sell your real estate property during that year. A newer instance is the sale of cryptocurrencies, which the IRS has constituted property. If you sold any cryptocurrencies late last year there is a good chance you have significant gains from the sale that can amount to a bigger tax bill than expected.
Going from a single-income to dual-income family, or when one partner gets a large raise or bonus, can both drive a larger tax bill. If your income increased but you didn’t take additional deductions you can find yourself underpaying your taxes and get hit with the penalties.
How much is the IRS underpayment penalty?
The amount you’ll be fined is based on how much you owe and how long you’ve owed it for. The typical penalty is 0.5 % of the total amount you owe calculated for each month you haven’t paid it. If you are hit with a penalty you may also be required to pay interest on the amount you owe. Basically, the whole experience sucks.
How to avoid a penalty next year?
If you received an income increase this year or expect a big bonus by year-end, make sure to file a new W-4 form with your employer to withhold more taxes with fewer allowances. If at the end of 2017 you’ve withheld the full amount of taxes, you won’t be penalized.
As we all know, 2018 is going to be a bit different than past years because of the new tax laws. If you want to get a sense of how much more you will have to pay in taxes next year versus this year, use our free Tax Calculator.
Underpaid taxes are usually driven by a positive occurrence – increased income. So congrats on that front! Having said that, if you underpaid taxes it also means unnecessary penalties and an outflow of cash you often did not expect. So estimating your tax bill ahead of next year’s tax season or talking with a financial planner will help you avoid penalties and budget better.
If you enjoyed this post, check out The New Tax Laws Explained.