Tax Additions: Situations Requiring You to Pay Extra Income Tax

Everyone loves getting tax breaks, but what can really impact your finances is forgetting about tax additions – extra taxes and fees you owe for income that should be reported when you file your income taxes.  Forgetting to include this income and not paying the taxes owed on this amount will hurt you in the long run.  Taxpayers are charged interest on the outstanding tax balance from the date taxes are due (April 15) until the taxes are paid in full. 

This means if you fail to include all of your tax additions in your annual return and get selected for an audit later, you will be charged interest for the entire period between when your taxes were due and when the error was found.  Understanding the additional taxes you might owe and the tax credits and deductions you may qualify for are both important in keeping 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. Their main source of income is their earned wages.  However, many individuals earn extra income beyond their wages, and the taxes owed on this income has not yet been reported to the IRS.  It is your responsibility to include these tax additions when you file your income taxes.

If all of your income for the year is reported by your employer on your W-2 form, you will not have any tax additions. However, if you work as a waiter or waitress and earn more than $20 a month in cash tips, you need to report those tips as income on your tax return.  This will increase your Adjusted Gross Income, and therefore increase your tax burden.

Following is a list of the most common situations that create tax additions.

Tips

additions

Legally you need to report your tips to your employer by the 10th of each month. If you work for a regular restaurant, this is probably part of the normal flow of business.  At the end of each shift, your employer may ask you to calculate how much in tips you earned and report it before you leave.  If this is the case, when you receive your W-2 form, it will already include the tips that your employer knows about.

However, the problem arises if you received tips that your employer does not know about. If you received other tips, then you will need to report them 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, 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.  Give them a Form 4070 (Employees Report of Tips to Employer) before the 10th of each month, and request that they include that information on your W-2 to make filing taxes simpler.

Rents

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If you own property and charge a rental fee, you will need to report all of that fee as income.  Rental income is taxed. Excluding rental income on your income tax paperwork is one of the biggest triggers for an audit, and the result can include huge back taxes if ignored.

Reporting rental income is very easy.   The IRS has tax forms specifically for reporting rental income and expenses.  All you need to do is track those numbers over the course of the year so that you can properly report them.  Click Here for the IRS article on reporting rental income and expenses.

Capital Gains

If you have any investments, you will need to report any capital gains (or losses) you experienced during the year.  A capital gain occurs when you sell an asset at a price higher than you purchased it for.  Capital gains alsoinclude dividend payments you received from stocks you own, so even if you don’t actually make stock trades during the year, you might still owe tax.

Larger capital gains occur when you buy or sell property that was held as an investment. If you sell your house that you’ve owned and lived in for 5 years, you will probably not owe taxes on any capital gains.  But if you “flip” a house by buying it, renovating it, and selling it 2 years later, you will owe capital gains on the profit you earned.

Capital gains are taxed at a lower rate than for other income, but they still need to be reported and paid. Click Here for the IRS FAQ for capital gains taxes.

Consumer Use Taxes

shipping wordcloud

When you make purchases at your local store, part of the price you pay includes a sales tax.  However, if you purchase an item online from another state, it is possible that you did not have to pay any tax at that time.  For this item, you would now be responsible for paying that tax yourself.  Instead of paying a sales tax, you would be paying a use tax.  (Since sales taxes are only collected at the local level, use taxes apply only to your state income tax return, not to your federal 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 to your location.  While the biggest online retailers, such as Amazon, have integrated sales tax charges into their purchases, 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 reporting use taxes varies greatly from state to state. Some states will have a specifically line on the income tax form for listing use taxes owed while others will require a separate form to be filed just for use tax.  Your state’s Department of Revenue can provide information about how use tax is handled in your state and what type of purchases may be exempt.  Check that website for details.  Then remember to check your receipts for purchases made from out-of-state companies to determine whether or not you paid sales tax with the purchase or will need to pay use tax now. 

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

Other Income is a blanket term for any other income you received during the year that was not reported to the IRS with a W-2 or a 1099 form. This typically includes things like cash prizes and award winnings, gambling earnings, and any money you earn on the side as cash, either through your own business or for something like pet sitting.

All of these “other” forms of income are reported using the standard 1040 form and Schedule 1. 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 1.  On line 8 of Schedule 1, the form asks you to report “type and amount” of your “other income.”  So if you received $26 for attending jury duty, you would list that there. 

Late Filing Fees

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Late filing fees represent “extra money” you may need to pay when you are filing your income taxes.  If you do not file your taxes by the deadline, usually the middle of April, you can be charged both a failure-to-file penalty and a failure-to-pay penalty (if you owe money to the IRS).   Currently the fee for filing late is 5% of the unpaid taxes for each month or part of the month that your taxes are late.  And the fee for paying late is .5% of your unpaid taxes.  The IRS website says that “You should file your tax return on time each year, even if you’re not able to pay all the taxes you owe by the due date. You can reduce additional interest and penalties by paying as much as you can with your tax return.” 

This should help you see how important it is to file your income tax paperwork 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.  This will give you an additional 120 days to file with no late fee penalty. Click Here for the IRS article on late fees.

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Challenge Questions

  1. What other items, other than you initial income from your paycheck can be taxed?
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  3. In your opinion, should people pay taxes? If so, why. If not, why not?
  4. Using examples, explain what Capital gains is.