(disclaimer: this is not legal advice consult with a licensed professional)
Are you stuck asking yourself “why do I owe money on my tax return?” If so, don’t feel alone as this is the situation for countless Americans after the recent tax filing season.
Small business owners reporting income on their individual return should utilize a bookkeeping service through a qualified expert, like SynkBooks, to reduce the risk of overreporting income.
Despite pandemic relief reducing the tax burden for 57% of Americans in 2021, the other 43% are left wondering what caused the dramatic increase in taxes owed, calling on the need to understand contributing factors and ways to minimize your burden in the next filing season.
What Factors Can Cause an Increase in Tax Owed?
Job Change
Employee turnover was at an all-time high with studies showing nearly 69 million Americans quit their jobs in 2021 (Tappe, CNN). Job openings in every industry popped up, increasing the demand for qualified labor.
As a result, many Americans made the transition into new positions, accepting higher pay along the way. Depending on the pay increase of your job change, you may have been pushed up into a new tax bracket.
Let’s say you made $40,000 in 2020, accepted a new job with a $50,000 salary in 2021, and are a single taxpayer. Although the increase in pay might not seem substantial, $10,000 of that income is subject to a 22% tax bracket while the original $40,000 was only subject to a 12% tax bracket.
New Side Hustle
The ease of advertising on social media and the simple setup of small businesses led to 5.4 million new business applications in 2021. Small businesses organized as a Sole Proprietorship or Single-Member LLC report all income and expenses on Schedule C of the 1040.
Since the IRS determines this income as self-employed, you may be on the hook for paying self-employment taxes on the income, which is 7.65% of your net profit. In addition to self-employment taxes, your income would also be taxed at ordinary income rates, further increasing your tax liability.
Business Income
Business income not reported on the Schedule C could also help answer your lingering question: “why do I owe money on my federal tax return?” S-Corp and Partnership income gets passed through on a K-1 and reported on your 1040.
Many businesses bounced back from the recent pandemic with an uptick in sales during 2021, increasing the taxable income you are required to report. If you are a small business owner and still haven’t seen sales levels revert back to normal, it may be time for a change.
Capital Gains
Watching your investment account grow can be great until it reaches tax time. Many Americans saw increases in stock market investments, resulting in a greater tax liability.
Capital gains are taxed based on the holding period with short-term sales taxed at ordinary income rates and long-term gains taxed at rates of 0%, 15%, or 20% depending on the situation.
If you were a business owner that sold a portion or all of your business during the tax year, you could be subject to capital gains taxes on any amount over your basis.
Advanced Child Tax Credits
As a part of pandemic relief, the IRS issued temporary advance payments of the Child Tax Credit during the last half of 2021. Normally, the Child Tax Credit is claimed in full on your 1040.
Taxpayers who received these advance payments saw a one-half reduction of the credit claimed on their individual returns, reducing any potential refund and increasing their tax liability. The entire portion of the credit was received, just at different points in the year.
This credit began phasing out at $200,000 for single filers in 2020, while 2021 saw a phaseout at just $150,000. If you were under $150,000 you would be entitled to the full credit; however, taxpayers in the $150,000-$200,000 range may have seen a reduced credit.
Cryptocurrency
Tax law surrounding cryptocurrency transactions has been gray for the past few years. However, in recent years, the volume of trading and popularity has ramped up causing the IRS to issue additional guidance.
Cryptocurrency now needs to be reported like any other capital gain, giving way to capital gain tax rates. More 1099 statements were issued in the past year with the new guidance being released, meaning you could have received a tax form you weren’t expecting.
Most cryptocurrency transactions don’t have any federal or state taxes withheld, leaving you on the hook for the tax bill at year-end.
Student Loan Interest
Interest accumulating on your federal student loan balances was halted in 2020 and has not yet resumed. Student loan interest is an above-the-line deduction for up to $2,500.
If you took out federal loans for college or other post-secondary education, you were probably deducting a portion of the interest each year. Depending on your loan balance and accumulated interest, the $2,500 reduction of taxable income might have completely disappeared, increasing your burden.
Inflation Adjustments
Each year, the IRS adjusts certain tax return deductions and credits for inflation, resulting in some favorable and unfavorable changes. The tax brackets and standard deduction changed from the prior year to account for the increase in inflation.
Child Changes
Empty nesters face more than additional free time. Claiming children has many tax benefits, including special credits and deductions. Parents with children over 23 years of age are no longer able to claim these expenses, negatively impacting taxable income.
Additionally, children under 23 years of age and in college gave way to the American Opportunity Tax Credit, which was $2,500 per qualifying child off your tax liability. The inability to claim this credit could be determinantal to your tax bill.
How Can I Improve My Tax Situation for Next Year?
Adjust W-4
After evaluating your tax position, if it becomes apparent the issue was your new job, there is a simple step you can take to fix your position for next year, so you don’t have to ask yourself “why do I owe money on my state and federal tax returns?”
Form W-4 controls how much taxes are withheld from your paycheck. On this form, you can select your expected income and adjust for dependents, side job income, and other business income. Additional withholding can also be requested here to build up your federal taxes paid in.
Tax Plan
Tax planning for your specific tax situation can lead to creative strategies that reduce your liability at the end of the year. Effectively timing the sale of investments, remitting proper quarterly tax payments, and taking business deductions are all possible with a tax plan.
Tax planning for small businesses includes monthly bookkeeping procedures, ensuring all income and expenses are recorded. Neglecting the accounting function of your business can lead to overstated income when expenses are missed. Additionally, projecting your income through the end of the year gives key insight into your potential profit or loss.
Creating a tax plan on your own opens the door for errors and missed items, especially if you are running a small business. As a result, many business owners turn to an expert bookkeeper to take on the bookkeeping function, ultimately producing accurate numbers for your tax plan.
Estimated Tax Payments
Small business owners, freelancers, and other self-employed individuals may be required to remit estimated tax payments each quarter. The IRS requires a safe basis of payments, meaning 100% of your prior year’s tax liability needs to be paid throughout the year.
Making estimated tax payments is a great way to ease your tax burden at the end of the year, but still pay in all the required payments. Both federal and state estimated tax payments may be needed.
Hire an Expert
Determining the contributing factors affecting your tax liability can be tricky if you aren’t well versed in the details of your tax situation. Hiring an expert can be just what you need, not only to keep track of your small business but to also properly plan for your tax burden.
As a small business owner, you have an expanded duty to meet certain bookkeeping tasks throughout the year to maintain effective cash flow and to keep your business running smoothly. Outsourcing your bookkeeping function can give you more time to focus on other important areas in your busy schedule.
Summary
Understanding the contributing factors to your tax liability and effective ways to combat a high tax bill next year are two areas essential when looking to answer, “why do I owe money on my tax return?”
One of the top contributing factors is the start of a new business or the growth of an existing business, calling on the need to have a qualified bookkeeper working alongside you.
SynkBooks has a team of knowledgeable experts who understand the tax implications running your own business can bring on, which is why they offer bookkeeping services, giving you the tools needed to properly track income and expenses throughout the year.