We are often asked, “what causes tax debt?”
Easy answer: underwithholding. Debt is a topic that most of us try to avoid discussing. When we individually owe debt, there are often feelings of shame. How did I let this happen? These same emotions arise with tax debt, especially when that tax debt sticks around for years. But owing tax debt alone is not unique and does not make you a bad person. More often than not, tax debt originates from small simple mistakes that overtime snowball into large problems.
The most common reason to owe tax debt is underwithholding. This simple reason is a bit more complex depending on income type. Either standard w2 wages, self employment income, or random unforeseen asset liquidation.
Underwithholding W-2 Wages
Most people earn w-2 wages from their employer, and often underwithheld the correct amount. Perhaps they don’t quite understand the w-4 form, or how income from other sources, kids, spouses etc. might affect it. This small mistake might generate a small balance, but once on repeat, that can grow to a large problem.
Underwithholding Self-Employed Wages
Another type of underwithholding would be better phrased as not-withholding. Self-employed individuals are responsible for depositing their required tax payments quarterly. Yet most don’t know this and don’t pay any estimated tax withholdings, and then when they file they are hit with a large tax liability. This liability is too much to pay off, so they either go on payment plans or ignore it to pay later. Next year rolls around, and it happens again, until eventually the monthly payment plans are no longer affordable.
Underwithholding Asset Liquidation Income
Another underwithholding example is unforeseen asset liquidation, or in other words, cashing out something and then not paying taxes on it. This could be 401k, IRA, stocks, home sales etc. When these events happen, you need to calculate the tax ramifications of that event to withhold properly. Often, people need that money, and therefore don’t pay the IRS.
Other common reasons for tax debt are related to business and payroll withholding and the need to operate a business rather than deposit taxes to the IRS, but we will touch upon that in another article. The most common reason to owe tax debt is you didn’t pay enough into it. That’s it. Why you didn’t could be you didn’t know better, you needed the money, or you were going to pay it, but just not now. Unfortunately, the taxes on your income are due immediately, since that is not your money, at least not all of it. These small balances add up over time quickly, and soon you could be like the millions of American’s owing over $10,000 in taxes to the IRS.
If you do owe tax debt and found yourself in need to learn what options you have, give us a call 800-822-4122 or go to https://taxdebtservices.com/doiqualify/, we can help.