Everyone loves getting tax breaks, but what can really ruin your finances in the long-run is forgetting about tax additions – extra taxes and fees that you need to add on to your tax bill. Missing these extra taxes will hurt – taxpayers are currently charged 6% APR on all outstanding tax balances.
This means if you fail to include all of your tax additions in your annual return and get caught by an audit later, you will be charged that interest rate for the entire period between when you first filed your taxes and when the error was found. While it is not nearly as fun to find any additional taxes you might owe compared to finding tax credits and deductions for which you may qualify, it is just as important to keep your finances healthy.
Why do tax additions exist?
Generally speaking, the government wants to make it as easy as possible for you to pay your taxes, so most people do not have any significant tax additions to report. Tax additions almost exclusively come from extra income earned, but has not yet been reported to the IRS.
For example, if all of your income for the year is reported on your W-2 form, you will not have any tax additions. However, if you work as a waiter or waitress and earn a lot of tips in cash, you still need to report that income on your tax return, which will increase your Adjusted Gross Income, and therefore your tax burden.
The following is a list of the most common reasons why you will have tax additions.
Legally you need to report your tips to your employer by the 10th of each month. If you work for a normal restaurant, this is probably part of the normal flow of business – when you receive your W-2 form, it will probably already include your tips that your employer knows about.
The problems only arise if you received other tips that your employer does not know about. If you received other tips, then you will need to report it separately using a Form 4137.
Keep in mind that your life will be much easier if all tips are reported to your employer. If you use a Form 4137, you cannot use the 1040 EZ (and must use one of the longer forms), and the tip amounts can be harder to track over the course of a full year compared to just a month. If your employer does not already keep track of tips, you can ask that they do, and give them a Form 4070 before the 10th of the month, and request they include that information on your W-2 to make filing taxes simpler.
If you own property and charge a rental fee, you will need to report all of that fee as income, and it is taxed. Excluding rental fees is one of the biggest triggers for an audit, and can result in huge back taxes if ignored.
Thankfully, reporting your rental income is very easy – there are parts of the Form 1040 specifically set aside to report all rental incomes. Click Here for the IRS article on reporting rental income and expenses.
If you have any investments, you will need to report any capital gains (or losses) you have incurred. This includes dividend payments, so even if you don’t actually make trades, you might still owe tax.
Bigger capital gains amounts will come if you buy or sell property that was held as an investment. This means if you sell your house that you’ve owned for 5 years, you will probably not have any capital gains owed, but if you “flip” a house by buying it, renovating it, and selling it 2 years later, you will owe capital gains.
Capital gains are taxed at a lower rate than other income, but still needs to be reported and paid. Click Here for the IRS FAQ for capital gains taxes.
“Use Taxes” are effectively equivalent to sales taxes, but they are responsibility of the buyer to pay, not the seller. All of the above taxes typically need to be filed both at the state and local level, but since there is no federal sales/use tax, this can only apply to your state return.
Use taxes come up in cases where you normally would owe a sales tax, but for one reason or another none was paid. The most common example is goods purchased from sellers online and shipped – while the biggest online retailers have integrated sales tax, many smaller sellers have not. If you purchase goods online and did not pay a sales tax, you will need to report the purchase and the taxes owed on your state tax returns.
The exact process for doing so varies greatly from state to state. Some states will have a box specifically for this on the normal income tax return, while others require a separate form to be filed just for use tax (often requiring the receipt for the tax).
Many people ignore the Use Tax because it can be complicated to file for very small amounts. However, if you do get caught dodging Use Taxes, fines and penalties are steep – in addition to high interest rate penalties, there are failed filing fees, and potentially even jail time if the amounts are high enough.
“Other Income” is a blanket term for any other income you received for the year, but was not reported to the IRS with a W-2 or 1099 form. This typically includes things like prizes and award winnings, gambling earnings, and any money you earn on the side as cash (either with your own business, or just something like babysitting).
All of these “other” forms of income are reported using the standard 1040. The exception is if you are earning extra money from a side job or being paid cash for odd jobs – this requires the Form 1040 Schedule C. Note that this is technically the profits and losses from a sole proprietorship – if you are working odd jobs and earning income from it, it works exactly the same as if you were a business owner with yourself as the sole employee.
Late Filing Fees
While these may not necessarily be an addition you need to report on your tax bill, late filing fees are some of the most common ways tax bills grow.
If you do not file your taxes by the deadline, usually the middle of April, you will incur a huge late fee – typically 5% per month (compared to just 6% for the entire year if you cannot pay the full amount owed).
This means it is extremely important to file your taxes on time, even if you owe tax and cannot fully pay it. If you need extra time to file your taxes, for example if you are waiting for some paperwork relating to extra income you need to report, you can also file for a short-term extension, which gives an additional 120 days to file with no late fee. Click Here for the IRS article on late fees.