At tax time, it’s often difficult to predict how much you will owe or receive on a tax refund without actually paying your taxes. But there are some tell-tale red flags that can mean an unwanted tax surprise is coming your way, tax professionals say. Here’s how to spot the signs and keep you from getting financially derailed.
1. A 1099-NEC lands in your mailbox
A 1099-NEC reports income from professional activities, a side gig, or as an independent contractor. The money your customers paid you is on this form if it was at least $ 600 – and no tax withheld is likely. The IRS and maybe even your state will likely be looking for taxpayers’ money from you by April 15th.
“More and more people are part-time, driving Uber, or delivering for DoorDash,” said Eric Fletcher, auditor at Thompson Greenspon in Fairfax, Virginia. “And that income is reported to them as 1099.”
How to deal with it: You are generally not taxed on gross income for this type of work, but rather on net income or profit, says Fletcher. Gathering your receipts and other information about your business expenses can reduce this net income and therefore lower your tax burden. Contributing to an IRA could also lower your 2020 taxable income if you do so by April 15, he says.
2. You completed a new W-4 last year to reduce paycheck withholding
A W-4 is the form you use to tell your employer how much tax you need to withhold from your paycheck. Many people may have filled out a new W-4 in 2020 to reduce these withholdings and get more take-away pay to make ends meet. But that could mean a nasty tax time surprise for many filers, says Abby Donnellan, CPA at Anders CPAs and Advisors in St. Louis.
“Their withholding tax was adjusted, and they didn’t realize it until the end of the year when they were used to a few thousand dollars back and now have to pay a few thousand dollars,” she said.
Here’s how to do it: Consult a tax advisor or use a tax calculator now to give you more time to plan for any tax refund deficits or unexpected tax charges. If necessary, readjust your W-4 so you don’t run into the same problem next year.
3. Your investments did well in 2020
If the market raised your portfolio or you sold some investments in the past year, your tax position may not be what you expected, warns Donnellan. “There could be some big capital gains,” she says.
How to Deal with It: There may not be much you can do now to offset those capital gains since December 31st has come and gone. However, there are some strategic steps you can take now for a better 2021, including reviewing your situation more often. “I would suggest at least quarterly that you review your investments to make sure there is no income that you weren’t expecting,” says Donnellan.
4. You have received unemployment
Unemployment income is not tax-exempt. “It will be subject to income tax, and that includes any additional unemployment benefits provided by the federal government,” says Fletcher. You will likely get a Form 1099-G in the email stating how much you received, and the IRS and your state may want a cut by April 15th.
How to do it: If you don’t have the cash to pay your tax bill by April 15th, know that the IRS offers installment payment plans that you can use to pay over time. And if you become unemployed in 2021, you can have 10 percent withheld on taxes from every payout, which could help prevent another tax surprise next year.
Tina Orem, NerdWallet
Tina Orem is the tax authority for NerdWallet. Her work has been published in various local and national branches. Continue reading