Why Do I Owe So Much This Year?

The IRS is not trying to trick you. They don’t want you to owe a lot of money; it doesn’t do anybody any good. But it happens, and here are some of the most common reasons why:

  1. Checking the “married” box on your W-4. Changing from “single” to “married” on your W-4 causes a lot less to be withheld from your paycheck, due to (I assume) an archaic assumption about married, single-income households. If both spouses continue to work, then there’s generally no change to your combined/overall tax situation, so you can end up being significantly under-withheld by checking the “married” box on your W-4.
  2. Withdrawing a lot of money from a retirement account, before retirement age. Generally, when you take an early distribution from a retirement plan, a flat rate of 20% for federal and 8% for Oregon state taxes will be withheld. If you’re in the 10% federal tax bracket and the 8% state tax bracket, you’re in good shape; the income taxes and the 10% early-distribution penalty will be covered. But say, for example, that the withdrawal increases your income enough to push you into the 25% federal bracket and 10% state bracket; you may end up owing an addition 5% in federal tax, plus 2% in state tax, plus another 10% in early-distribution penalty. And on top of that, many of your tax deductions and credits may be reduced, as a result of having a higher income for the year. It can be a real mess; I’ve seen people owe many thousands of dollars for this kind of thing.
  3. Taking a 2nd job. Be careful with this one. If you take a second job, you’ll want to reduce your withholding for your primary job, to cover the taxes due on the additional income. (Even though you’re having taxes withheld from the income from the second job, it’s almost never enough.) And if you’ve got three or four or five jobs, none of which pay very much, you can inadvertently get yourself into a really ugly position; you may owe a significant amount in tax because your combined income is high, but each job may withhold only a very small amount in taxes (since as far as they know, your income is very low).
  4. Taking on contract (self-employment) work “on the side.” Assume that anywhere from 20-45% of what you’re getting paid will need to go towards taxes. See here.
  5. No longer qualifying for the Earned Income Credit. The rules on the earned income credit aren’t terribly intuitive. If you qualify in one year, you may get a really big refund. Make $10,000 more the following year, and all of sudden you may owe a lot. It’s hard to explain, but it happens, especially when there’s self-employment involved. If the Earned Income Credit makes up a big portion of your tax refund, make sure you understand the rules.
  6. Selling a rental house. Unless the property has decreased in value, you typically have to pay back any depreciation you’ve ever claimed on the house in the year of sale.
  7. Receiving spousal support. Spousal support is taxable income!

 

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