In my work as a VITA volunteer, AND in my personal life, I’ve run across a larger-than-usual number of people this year whose tax returns left them with a need to pay extra to the IRS for 2021.
- When it’s a small amount, it’s no big deal — in fact, some folks see that as the ideal situation. They’d prefer to owe Uncle Sam a little at the end of the year, rather than getting a big refund, which essentially means they have given a no-interest loan to Uncle Sam during the year.
- But when people owe a large amount of income tax when they file, that means something has gone wrong with the system: not enough taxes have been withheld from their income throughout the year.
To AVOID owing substantial income tax at the time you file, your best step is to check the IRS Withholding Estimator. This easy-to-use tool allows you to make sure you are having an appropriate of federal income tax taken out of each paycheck. The tool asks you to enter information about your filing status and number of dependents, and then asks you to enter information from your most recent pay stubs — both year-to-date information AND information for the current pay period. Based on this information, the tool will help you see if you are having the appropriate amount of tax withheld from your paychecks.
Why does this happen and when do I especially need the withholding estimator? Checking on your tax withholding is especially helpful in certain situations:
- When you have income from several different sources: if you have several different part-time jobs, or a mix of retirement income and employment income, OR if you have a spouse who also has income. In these situations, none of your income sources knows how much your total income for the year is likely to be. The problem with that is that they might withhold only a small amount of tax, on the assumption that this part-time job is your only income for the year. However, when you add up all those different sources, you may be in a higher tax bracket than any one of those sources would have guessed. The withholding estimator can help make up for the fact that no one income provider knows your whole income picture.
- When your family situation changes: you get married, or are divorced or widowed, or you add new members to your tax household. In these cases, the withholdings you have had for years may now be inappropriate for your new situation. Some of the people I’ve seen this year who have gotten unexpectedly bad news with their tax return have been new widows. This was their first year filing single, and they owed more taxes than expected, due to the smaller standard deduction that applies to single people.
The IRS withholding estimator covers only federal income tax. When it comes to state income tax, Iowa has a Withholding Calculator that may be helpful. My impression is that it may not be quite as helpful, but it is worth checking out. Another option is to talk with your tax preparer or to attempt a tax calculation for 2022 using 2021 tax forms or software, since tax rates typically do not change dramatically from one year to the next.
Penalties. It is important to be aware that the United States tax code requires that taxes be paid throughout the year, not just at the end of the year. If you end up owing TOO much at the end of the year, you may be charged a penalty for not paying enough into the system throughout the year. Most people can avoid that penalty by paying in throughout the year an amount at least as much as their tax bill for the prior year. People with incomes over $150,000/year can avoid the penalty by paying in at least 110% of what their tax bill was for the prior year.