4 Signs You're About to Get a Tax Surprise
By: Tina Orem - NerdWallet
Published: January 27, 2021
At tax time, it’s often hard to predict how much you’ll owe or receive in a tax refund without actually doing your taxes. But there are some telltale red flags that can mean an unwelcome tax surprise is headed your way, tax pros say. Here’s how to spot the signs — and how to keep them from financially derailing you.
1. A 1099-NEC lands in your mailbox
A 1099-NEC reports income earned from freelancing, from a side gig or as an independent contractor. Money your clients paid you is on that form if it was at least $600 — and there was likely no tax withheld. The IRS and maybe even your state will probably be looking for that tax money from you by the April 15 tax-filing deadline.
“More people are working side jobs or driving Uber or delivering for DoorDash,” says Eric Fletcher, a certified public accountant at Thompson Greenspon in Fairfax, Virginia. “And that income is going to come to them reported as a 1099.”
How to cope: You’re generally not taxed on the gross income for this type of work, you’re taxed on the net income or profit, Fletcher says. Gathering your receipts and other information about your business expenses can reduce that net income and thus cut your tax bill. Contributing to an IRA could also reduce your taxable income for 2020 if you do it by the April 15 tax-filing deadline, he says.
2. You filled out a new W-4 last year to reduce paycheck withholdings
A W-4 is the form you use to tell your employer how much tax to withhold from your paycheck. Many people may have filled out a new W-4 in 2020 to reduce those withholdings and get more take-home pay in order to make ends meet. But that could mean a nasty surprise at tax time for a lot of filers, says Abby Donnellan, a CPA at Anders CPAs and Advisors in St. Louis.
“Their withholding has been adjusted, and they didn't really realize that until the end of the year, when they're used to a couple-thousand-dollar refund and now they're having to pay a couple thousand dollars,” she says.
How to cope: Check with a tax pro or use a tax calculator now so that you have more time to plan for any tax-refund shortfalls or unexpected tax bills. If you need to, readjust your W-4 so you don’t encounter the same issue next year.
3. Your investments did well in 2020
If the market lifted your portfolio or you sold some investments last year, your tax situation may not be what you expect, Donnellan warns. “There might be some large capital gains coming,” she says.
How to cope: There may not be a lot you can do to offset those capital gains now, because Dec. 31 has come and gone. But you can make some strategic moves now for a better 2021, including reviewing your situation more frequently. “I would suggest quarterly, at least, looking at your investments to make sure there's not a bunch of income that you're not expecting,” Donnellan says.
4. You received unemployment
Unemployment income isn’t tax-free. “It will be subject to income tax, and that also is going to include any additional unemployment compensation that's provided from the federal government,” Fletcher says. You’ll likely receive a form 1099-G in the mail showing how much you received, and the IRS and your state may want a cut by April 15.
How to cope: If you don’t have the money to pay your tax bill by April 15, know that the IRS offers installment plans that allow you to pay over time. And if you’re receiving unemployment in 2021, you can have 10% withheld for taxes from each disbursement, which could help prevent another tax surprise next year.