The federal government requires you to pay your taxes as you earn money, rather than waiting until you file your taxes and then making a lump sum payment. For most people, employer withholding covers their tax liability so they don't owe extra interest or penalties. Depending on your circumstances, there are several reasons why you might not be having enough withheld from your paycheck to cover your tax liability.
Incorrect W-4 Allowances
Your employer bases your federal tax withholding on your tax filing status and the number of personal allowances claimed on your W-4. The more allowances you claim, the lower your withholding. Accordingly, if you've claimed too many allowances, your employer would take out enough for your federal income taxes. For example, if your W-4 is outdated and still includes personal allowances for your two children whom you aren't claiming as a dependent anymore, you'll likely have too little withheld.
Your withholding might also be off if you work multiple jobs and claimed exemptions on all of your W-4s. According to the Form W-4, if you work multiple jobs, you need to use the Two-Earners/Multiple Jobs Worksheet to figure your allowances and only claim the allowances on the W-4 for your highest paying job. For example, if you're entitled to two allowances and you claim two on the W-4 for each of your three jobs, you'll have too little withheld during the year.
Not all sources of income are subject to withholding. For example, when you make money off the sale of stock, get interest paid to you on your bank accounts or make money as an independent contractor, none of those have federal income taxes withheld even though it's taxable income. As a result, your employer's withholding may not be enough to cover the additional taxes you owe on your other income.
Correcting the Problem
You're allowed to change your W-4 at any time to reflect changes in your life. For example, if you got divorced and can't claim your kid as a dependent any more, you need to update your W-4 to reduce the number of allowances and change your filing status from married to single. If you have outside income, you can also request that your employer withhold an extra dollar amount each paycheck. For example, if your investment income causes you to owe an extra $1,200 of income taxes and you get paid monthly, you can have your employer withhold $100 extra per paycheck.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."