I Owed Taxes This Year and I Don't Know Why: Common Causes To Changes in Your Tax Bill

Tax season often brings a mix of emotions for individuals – some anticipate a refund, while others may face an unexpected tax bill. If you find yourself owing more taxes this year compared to last year, you may be wondering what changed in your financial situation. There are several common reasons why your tax liability could increase, ranging from changes in your employment status to financial decisions like selling stocks or withdrawing from retirement accounts. In this post, we’ll explore some of the key factors that could contribute to owing taxes this year and offer tips on how to prepare for next year.

1. Changing Jobs or Switching to Self-Employment

One of the most common reasons for a higher tax bill is a change in your employment situation. Whether you’ve switched jobs, received a promotion, or started working as an independent contractor, these changes can impact your overall tax liability in different ways.

• Job Change and Withholding Adjustments: If you changed jobs mid-year, your new employer may not have the same withholding allowances or tax structure as your previous employer. Even if your income level remains the same, a change in your withholding can lead to underpayment of taxes, especially if you didn’t adjust your withholding after the switch. Many people mistakenly assume that their new employer will automatically withhold the correct amount, but that’s not always the case. Checking your withholding status and making adjustments through your new employer's payroll department can help prevent this issue.

• Switching to Self-Employment: If you transitioned from being an employee to working as a freelancer or self-employed individual, your tax situation changes significantly. As a self-employed person, you’re now responsible for paying both the employer and employee portions of Social Security and Medicare taxes (commonly known as self-employment taxes). This can add a substantial amount to your tax bill. Additionally, since there is no employer withholding your taxes, you may need to make quarterly estimated tax payments to avoid a large tax bill at the end of the year.

  
  

2. Selling Investments or Stocks

Another reason you may owe more taxes is selling investments or stocks. When you sell investments, such as stocks, bonds, or real estate, you could trigger capital gains taxes, which may lead to a higher tax bill.

• Capital Gains Tax: The sale of assets like stocks or mutual funds is subject to capital gains tax, which can be either short-term or long-term depending on how long you held the asset. Short-term capital gains (from assets held for less than a year) are taxed at ordinary income tax rates, which can be as high as 37%, depending on your income level. Long-term capital gains (from assets held for over a year) are generally taxed at lower rates (0%, 15%, or 20%), but if you’ve sold a significant amount of stock or other assets, these taxes can still add up.

• Taxable Investment Accounts: If you have a taxable investment account, it’s important to track your gains and losses throughout the year. Even if you didn’t realize gains or losses by selling, you might have dividends or interest income that is taxable. These types of income are often overlooked but can increase your taxable income and lead to a higher tax liability.

• Tax Loss Harvesting: On the flip side, if you sold investments at a loss, you could offset some of your gains through tax loss harvesting. However, if you have a large amount of gains and no losses to offset them, you could face a significant tax bill.

  
  

3. Withdrawing from Retirement Accounts

Another common reason for an increase in taxes is early or large withdrawals from retirement accounts such as 401(k)s or IRAs. While these accounts offer tax advantages when the funds are contributed, withdrawals are generally subject to tax, and the rules can vary depending on the type of account.

• Traditional 401(k) or IRA Withdrawals: If you took a distribution from a traditional retirement account (e.g., a 401(k) or traditional IRA), the amount you withdraw is generally considered taxable income. If you made a large withdrawal or took an early withdrawal (before age 59½), you could face both income tax and an additional 10% early withdrawal penalty. The taxes owed on these withdrawals can push you into a higher tax bracket, resulting in a larger tax bill.

• Required Minimum Distributions (RMDs): If you are 73 or older and have a traditional 401(k) or IRA, you are required to begin taking minimum distributions. If you fail to take the required amount or take out more than necessary, the IRS imposes a penalty, and your total taxable income may increase, leading to higher taxes.

  
  

4. Changes in Family Status or Dependents

Changes in your family or household situation can also impact your tax bill. For example, if you had a child, got married, or experienced a divorce, these life events can alter your tax obligations.

• Child Tax Credit and Dependent Deductions: If you no longer have a qualifying dependent or your dependents have aged out of eligibility for certain credits, you may lose the Child Tax Credit or other deductions that were available to you last year. Similarly, if you no longer qualify for head of household status (due to a change in marital status or living situation), you could face a higher tax rate.

• Divorce or Separation: If you went through a divorce or legal separation, your filing status may have changed from “Married Filing Jointly” to “Single” or “Head of Household.” This could increase your tax rate and reduce the credits and deductions you were eligible for under your previous status. If child custody arrangements changed, it may also affect which parent is entitled to claim children as dependents.

  
  

5. Failure to Adjust Withholding or Estimated Payments

Finally, one of the most common reasons for owing taxes at the end of the year is failing to adjust your withholding or estimated payments throughout the year.

• Underwithholding: If you didn’t update your W-4 form when your financial situation changed (such as when you got a raise, changed jobs, or started a side hustle), you may not have had enough taxes withheld from your paycheck. This can lead to owing money when you file your tax return.

• Quarterly Estimated Payments: Self-employed individuals, retirees, and others with income that isn’t subject to automatic withholding may be required to make quarterly estimated tax payments. If you missed these payments or didn’t pay enough, you could owe a large sum when you file.

  
  

6. Conclusion: How to Prepare for Next Year

Owing more taxes than expected can be frustrating, but understanding the reasons behind it is the first step in preventing the same issue next year. To avoid an unexpected tax bill, it’s important to regularly review your withholding, keep track of major financial changes like job transitions or investment sales, and plan for retirement account withdrawals. If you have a significant change in your financial situation, consulting with a tax professional or accountant can help you navigate these changes and ensure that you are properly planning for taxes in the future.

By taking proactive steps and staying informed throughout the year, you can avoid surprises and potentially lower your tax liability for next year’s filing season.