One of the most unpleasant surprises in your financial life could involve an unexpected income tax bill from the Internal Revenue Service after you file your taxes. The design of the income tax system is pay as you go, but some people end up owing money at the end of the year.
Pay As You Go
The income tax system that is set up by the Internal Revenue Service is set up to have you pay taxes as you earn money throughout the year. This way, you do not have to come up with all of the money at once for your tax bill at the end of the year. If you are self-employed or own a business, you are supposed to pay taxes on a quarterly basis to the IRS. If you work for an employer, part of each check goes towards paying your taxes.
When you are a self-employed individual, you have to pay estimated taxes to the IRS. With this type of tax system, you have to estimate how much money you will make for the year, determine how much tax you would pay on that amount and then send a quarter of that amount to the IRS four times per year. If you do not calculate correctly, you could end up sending too much; if you make more money than you anticipated, you may not have sent enough to cover the entirety of your tax bill.
When you work for someone else, part of your paycheck is typically deducted and sent to the IRS before you touch it. The amount taken out depends on the information you provided on your W-4 form when first hired. The number of exemptions you claim determines how much is taken out of your check. If you do not have enough withheld from your check, you might end up owing money to the IRS.
The income tax system in the U.S. uses income tax brackets. As you make more money, your income tax rate increases. If you make more money than you did the previous year, you have to pay more money in taxes. If you do not plan for this increase and keep saving at the same rate, you could create a deficit and can end up having to pay more taxes at the end of the year.
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