The time has come. You are reviewing your tax return and finally reach “The Amount You Owe.” Some of us are more familiar with that line than we would like to be. Unfortunately, in some instances, that line can bring a very big unwanted surprise.
You Must Make Estimated Tax Payments
I’m looking at you, my self-employed individuals. Unlike a W2 employee, when you are self-employed you do not have your employer withholding federal taxes from your income. There is no one withholding social security taxes or medicare taxes either (defined as your self-employment tax). That does not mean that you are not required to pay them. In fact, if you do not pay those taxes throughout the year you are responsible for paying the entire amount at year-end.
You can avoid this by making quarterly estimated (ES) tax payments. ES payments take the place of federal tax, social security, and medicare withholdings that are deducted from a W2 employee’s pay. There are different methods to calculate your quarterly estimated tax payments. One method is to use your prior year federal tax liability to estimate how much you will owe for the current year. For example, if your tax liability was $4k in 2012, you should make quarterly payments in 2013 of $1,000. The IRS also provides a worksheet (Form 1040-ES) to calculate your estimated tax payments. Additionally, some taxpayers find it easier to calculate their ES payments based on monthly net profits.
The important thing is to make your ES payments!!!
Not Enough Federal Tax Withheld
If you’re a W2 wage earner you may still receive a large year-end tax liability. One reason, not enough federal income taxes were withheld.
You can always increase the amount of federal taxes withheld by changing your W4 Employee’s Withholding Allowance. The amount of taxes your employer deducts is based on your number of allowances.
Smaller Allowance à More Taxes Deducted = Smaller Tax Liability.
A good activity is to visit the IRS website and use the IRS Withholding Calculator. After you input your information, the calculator will tell you what your projected year-end tax liability will be and how much you will owe. It also provides suggestions on how to change your withholding allowances going forward.
You can also make estimated tax payments. It’s not only a solution for self-employed individuals.
Below I have included a non-exhaustive list of other reasons why you may have a large year-end tax liability. I would encourage you to contact a tax professional for tax planning if you fall within the following categories:
- Retirement Income with No Federal Withholdings
- Early Withdrawal of Retirement Income
- Lawsuit Income
- Sale of Home
- Sales from Investments
- Substitute Federal Return (IRS Filed Return for you)
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