What makes you owe money during tax time?

[Midnight_Raven]

This is one thing that I find strange. My father keeps telling me that I'm going to have to owe money to the IRS next year due to my income and me being single.

I don't get that rational behind it though... I thought the tax return was to return a small portion of the income which they take from each of your checks during the year.

If I'm paying taxes from my gross income each week why would I be taxed again when income tax times comes around.... according to what my father is saying... I just don't get it. He could be wrong and I'll be fine, but I just want to see what people, who have more time dealing with taxes, know.

I'm wondering what's the reason that makes people owe money to the IRS. Is it land ownership? Is it for saving money? Is it based on if your married vs single or if you have dependents or not? Is it just based on not claiming all your earnings?

 

[Miner]

The number of exemptions selected on your W-4 servers as an approximation of what your annual taxes will be, and the amount withheld each paycheck. Come April, ones annual income, minus the various deductions etc, yields the adjusted gross income and how much taxes are owed for the year. If the approximated withholdings are more than owed, one gets a refund, the opposite results in one owing money.

It really doesn't matter how much you make, or your marital status, its do your withholdings exceed your tax owed? An over simplification, but a starting point.

Miner

 

[NSX-Stalker]

You can take home a lot more per paycheck it you claim 10 exemptions. When the time comes you need to show it. The trick is to balance the exemptions relative to your income and decuctions to break even. If you owe close to zero you've done well.

 

[Vega$ NSX]

When I first started making money, paying taxes took me a little while to figure out. Here's what I've been able to distill over the years of paying and paying and paying and paying...


When you start making money, the IRS/Government is entitled to a share of it at the end of the tax year. How much you owe is a math formula derived by a percentage of your income. If you make a certain amount of money you pay a certain percentage. The percentage varies depending on how much money you make (called tax brackets). However, certain things, like being married or having kids, allow you to deduct some amount from the taxes you owe. These are called deductions. So two people who make the same amount of money pay the same amount of taxes. However, if one of them, say has a house, he is able to deduct a certain amount of home expenses and pay that much less than the guy who makes the same amount of money but doesn't own a house.

However, rather than pay all of your taxes in one lump sum at the end of the year, the IRS/Government has you pay it out averaged through the course of the year by taking a little bit out of each paycheck. The problem is that how do they know how much to take out? You may get bonuses on top of your regular paycheck that the IRS or even you didn't expect. You may also have deductions, like buying a house, in which you get to deduct certain amount from how much you owe. So at the end of the year, you tally up how much you really owe, versus how much you've actually paid. If you paid more taxes than you actually owe, then you get a refund. If you didn't pay enough, then you have to make up the difference.

When you first sign up with a company or start making income you fill out what is called a W-4 form. This form has a series of questions that you answer to come up with a list of exemptions. These exemptions are used to approximate how much the IRS thinks you'll need to pay at the end of the year and then bases it's paycheck to paycheck deductions based on that. It's not perfect or exact, so at the end of the year, it will either be higher or lower than what you actually owe.

Some people like to over pay month to month (take less exemptions) and then get a nice fat refund check at the end of the tax year. Think of it as an easy way to save money without noticing it. However, many people (including me) would rather owe a little bit of money at the end of the tax year. The reasoning behind that is because when you over pay, you are basically giving the government an interest free loan for a year. That is because you are giving money that is technically yours to the government over the course of year, only to be paid back at the end of that year. The financially savvy person would realize that the opposite holds true and that if you underpay your taxes, you will take home more money paycheck to paycheck in which you can do things with, such as invest in things that will make you more money. In the end you will need to pay that back at the end of the tax year, but you can keep whatever interest you made with it. However, there is a catch. If you owe too much money at the end of the year, the IRS catches on to this and will audit you and penalize you with interest. In my humble opinion, ideally you should set up your finances so that you pay around $1,000 or less at the end the tax year. That's enough to maximize your take home pay paycheck to paycheck, but not tip off the IRS that you are trying to take advantage of the free loan they are giving you.

 

[Semnos_NSX]

Well said! :smile:

 

[W]

Agreed with what everyone is saying. I'm sorry but your father is not correct if he really does believe that a single person will always have to pay additional taxes when they file a return. Maybe he already knows how much tax you're paying and by experience realizes that you haven't paid nearly enough taxes.

 

[nsxtasy]

The posts above have described, generally accurately, the way that the tax system works. However, none really described the difference in the likelihood of refunds between a single person and a married person.

The amount of taxes you pay is determined by the tax return you file at the end of the year. The amount of taxes withheld from your earnings during the year may be more, or less, than the amount of taxes shown on your return; if more was withheld, you get a refund, and if less was withheld, you owe money. The DEFAULT amount of withholding (for your actual number of exemptions and marital status) is designed to be roughly equal to your total taxes shown on your return, but your actual taxes can vary due to deductions etc as others have noted. And as others have noted, you can have the amount of withholding increased or decreased by declaring more or fewer exemptions, as well as having an additional amount withheld from each paycheck.

A single person pays higher tax rates for the same income than a married couple. For example, if you have a 2009 taxable income (line 43 of the 1040 tax return) of $50,000, the amount of tax is $8694 if you are single, and $6669 if you are married. For this reason, the DEFAULT amount of withholding tax is less for a single person than a married person. Either one could pay tax at the end of the year, or get a refund at the end of the year.

The highest likelihood of owing taxes at the end of the year is not for a single person or for a one-income married person, but rather, for a two-income married couple, assuming the default for withholding tax is used. That's because of our system of graduated tax rates (higher income gets taxed at a higher rate) and the fact that withholding tax is calculated on each person as though that is the sole income of the family. A single person earning $100,000 gets withholding tax calculated as though that is his family income for the year. A married couple with one spouse working and earning $100,000 gets withholding tax calculated as though that is their family income for the year. Both are likely to be fairly accurate, before considering exemptions and deductions. However, a married couple with both spouses working and each earning $50,000 gets withholding tax calculated as though $50,000 is their family income for the year, and this is at a lower tax rate percentage than a family with $100,000 of income. Because the two incomes, together, result in a family income of $100,000, that pushes them into a higher tax bracket, and there is a greater likelihood of owing tax at the end of the year than for a single person or a married couple with one wage earner.

Hope that makes sense.

I don't get that rational behind it though... I thought the tax return was to return a small portion of the income which they take from each of your checks during the year.

Your terminology is not correct, which is probably why you are getting confused. The tax return is the tax FORM that you return to the government, showing your income and deductions. The tax refund is the amount that the government sends you back if you paid more taxes in withholding from your earnings than you actually owed at the end of the year. You may get a refund, or you may owe money.

 

[VegasSpeed]

VegasNSX has some patience might I add. I would sum it up by saying every year we try and pay the amount we owe to the government every quarter or paycheck. When we "file" our return we find how much we really owed for that year. At the beginning of every year we guess what we will owe and try and pay that in each paycheck. Now depending on how you like to do things you can arrange to get a refund every year by overpaying to compensate for that or hardly pay at all so you get a 0% loan from the governement for 12 months on what you will owe them. As I read Bryan's post again I realize he said everything I just did. No shock there. This is what he is good at.

 

[docjohn]

I'm sure your question was geared twords employees being payed a set salary.As mentioned many folks recieve income beyond thier w-2 wages.Also you have not talked about a large segment of business owners who pay themselves as profit distributions usualy in the setting of partners bonus in llp's, s and c corps ect.Thus your income is a moving target and your taxes are only set after you have finished the year and can document all the inflows outflows.

 

[nsxtasy]

Yup. The illustration I gave is only for the most simple case, a person who earns paid income from employment, without all the other cash flows that can complicate the situation.

As Vegas noted, the whole idea of withholding tax (as well as estimated tax, which is a way of sending tax money to the government on a quarterly basis) is to pay your taxes during the course of the year. By doing so, you avoid a big tax bill at the end of the year, and may even have a refund coming.

 

[passline]

"Living in New Jersey!"

 

[Midnight_Raven]

Ah now I get it. So I guess as of right now I'll never owe because I have 0 exemptions set. So they are taxing me at the highest percentage and, in the end, the amount I'm really suppose to owe is less than what they removed from all my paychecks for the year, hence I get a refund.

Hm... so If I wanted to I could just add 1 extra exemption each year and see how much that gets my tax refund closer to zero, to maximize the amount I get in each paycheck vs waiting for it during the beginning of each year.

Thanks for the info guys. Great information can be gathered from NSXprime.

 

[nsxtasy]

Hm... so If I wanted to I could just add 1 extra exemption each year and see how much that gets my tax refund closer to zero, to maximize the amount I get in each paycheck vs waiting for it during the beginning of each year.

Yes, that's correct.

If you're wondering why people don't ask for a bazillion exemptions so they don't have to pay taxes through withholding... If you owe more than a certain fraction (I think it's 10 percent) of your taxes for the year, you have to start paying estimated tax during the year. Estimated tax is like withholding tax, in that you are paying your taxes in advance; unlike withholding tax, which your employer deducts from your paycheck, estimated tax is paid by the individual taxpayer in quarterly installments during the year. So they make you pay your taxes during the course of the year, one way (withholding) or the other (estimated).

 

[Vega$ NSX]

Yes, that's correct.

If you're wondering why people don't ask for a bazillion exemptions so they don't have to pay taxes through withholding... If you owe more than a certain fraction (I think it's 10 percent) of your taxes for the year, you have to start paying estimated tax during the year. Estimated tax is like withholding tax, in that you are paying your taxes in advance; unlike withholding tax, which your employer deducts from your paycheck, estimated tax is paid by the individual taxpayer in quarterly installments during the year. So they make you pay your taxes during the course of the year, one way (withholding) or the other (estimated).

It's more of a function of how much you owe rather than a percentage. Once you start owing more than $5-10K at the end of the tax year, it's raises the attention of the IRS. Typically they will give you a warning or might even charge you interest on that money. After that they will follow you more closely and it is in your best interest to pay your estimated quarterlies. *Ask me how I know :wink:

 

[nsx2tall]

Very nice summaries of page 1 and page 2 of the 1040 return. Will someone now explain to our friend Schedule A, Schedule C, Schedule D, AMT, K-1, 1099-misc, 1099-R, deduction phase out, depreciation and amortization? :biggrin:

 

[damthatbeaver]

As usual...great answers to an interesting question. I believe that you have to look at income tax as a way to get additional money back...I created a side company in order to write some things off and I have found that it helps out...as does learning how to do your own taxes...I am amazed that it scares sooooo many people!

Dam

 

[Understudy]

Hm... so If I wanted to I could just add 1 extra exemption each year and see how much that gets my tax refund closer to zero, to maximize the amount I get in each paycheck vs waiting for it during the beginning of each year.

If you go onto the IRS website they also have a withholding calculator on the main page towards the left side which will provide you a good estimation of what you should withhold. For those people that don't have complex returns and if you fill out the information correctly it should provide you a relatively accurate guide to what you'll want to withhold.

 

[4cruizn]

Good thread, I learned a few new things - thanks. Was just talking about this topic with a friend earlier this week. Hoping for a healthy refund this year myself.

 

[docjohn]

As was stated earlier getting a "healthy" refund really is a 0% loan you made to uncle sam.The key is to be as close to even with the irs.You can't win.If you owe money they can penalize you with an interest rate,if they owe you you get no interest benefit.Now if there are tax credits for stuff like electric vehicles then you could aply that credit to your amount owed,that is if you were going to buy the vehicle anyway.

 

[Midnight_Raven]

I've been doing my taxes for the past 3 years... but it wasn't anything significant... as a college student at most I was making was like 7K a year at most for food, books, and paying off some of my tuition.

Now that I've graduate and started working I felt a need to know what exactly I was doing by filing out those tax forms. You guys are the best I knew NSXprime is the place to go! .

 

[sahtt]

My advice is do not under or over pay by any significant amount, both will cost you money. My taxes are very complex and it's a disaster. I do most of it myself but the tax code can be overwhelming. If you are an employee and do not have complicated investments, tax time will become routine and shouldn't cost you more than a few hours a year.