There can be many answers to this question, but for the vast majority of U.S. tax filers paid as W-2 employees, the likely culprit is the under withholding of taxes.
There are several things that may occur during the year that can lead to a shortfall of tax withholding. Because of this possibility, we encourage you to review your W-4 form (your Employee’s Withholding Certificate) annually. The W-4 is an IRS form that tells employers how much tax to withhold from each paycheck, which is remitted to the IRS on behalf of the employee. The W-4 was revamped in 20201 and one of the major changes is that the form no longer asks for a number of allowances. If you have not updated your W-4 since this change, we suggest that you contact your HR department as soon as possible to review your current withholding amount and modify it to the correct tax tables, if necessary. An incorrectly completed W-4 form is one of the most common causes of tax shortfalls for US taxpayers that we come across.
Below, we have compiled a few common reasons that we often see for under withholding:
1) Incorrect W4 “filing status” selected – If you are married, it is possible that when you filled out your W-4 at your place of employment you checked the “married filing jointly” radio box. This appears to be the correct box to check for married people, but it actually withholds tax at a lower rate. As a general rule, if you are in higher tax brackets and/or want to be more conservative with your withholding amount, you may consider marking the radio box as “Single or Married filing separately.”
EXAMPLE: Taxpayer making $195,000 annual salary ($7,500 bi-weekly over 26 pay periods).
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- Filing status: Single or Married Filing Separately
Withholding each pay period: $1,480
Withholding for the year: $38,480
- Filing status: Single or Married Filing Separately
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- Filing status: Married Filing Jointly
Withholding each pay period: $1,094
Withholding for the year: $28,444
- Filing status: Married Filing Jointly
By selecting the filing status “single or married filing separately,” this taxpayer would have withheld $10,036 more in taxes for the year, a significant increase in tax withholdings.
You can select the “single or married filing separately” radio box even if you are married and file a joint return. The W-4 does not have to match your federal tax filing status. We strongly recommend contacting your CPA to discuss this option to determine if it may be advantageous for you.
2) Bonus, Stock Options, RSU’s – If you were paid a large bonus, stock options, or RSU’s, the tax withholding on these payouts, in most cases, is not calculated from your completed W-4. Instead, your employer withholds a flat 22% federal tax rate. Therefore, if you’re in a higher marginal tax bracket, this could create a large withholding shortfall. Some companies allow you to elect to withhold at a higher rate on these payouts, so check with your HR department to determine if you can withhold at the appropriate higher rate, if needed.
3) Changing jobs – When you change jobs in the middle of the year, your new place of employment does not know about other income you earned during the year. This results in the new place of employment thinking your annual income for the year will be lower, which could cause a potential shortfall in withholding. To help mitigate this risk, you can update your W-4 with your new employer to reflect this extra income.
4) Self-employment income – If you earned additional self-employment income as an independent contractor in addition to your W-2 income, you could incur a tax liability as well. 1099 independent contractors do not have tax withheld on their pay and these payments could result in unexpected balances due for some taxpayers.
The Krilogy® Tax team encourages you to review your W-4 selections on a regular basis, especially if any of the above items may apply to you. This exercise could help alleviate potential tax withholding shortfalls.
Please feel free to reach out to your Krilogy® team with any questions you may have. We’re here to help you feel confident about your tax preparation. You’re Ready.
1https://www.irs.gov/newsroom/faqs-on-the-2020-form-w-4
Krilogy® does not provide tax and legal advice. Krilogy® is affiliated with Krilogy Tax Services, LLC. Krilogy® Tax Services provides tax planning and preparation services for an additional cost to Krilogy® clients. You should consult your attorney or qualified tax advisor regarding your situation.
