How to Deal with a Payroll Underpayment from an Employer

A red brick will with large white letters spelling out "Tax."

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It’s tax time and if you’re reviewing the amount you had withheld in taxes and you owe money – keep reading.

Question about IRS Paycheck Withholding Shortfall

My former employers did not take enough taxes out of my paycheck each time I was paid. Now, I owe the IRS money. Do I have any recourse with my employer?

MoneySmart Answer:

That is a frustrating situation and unfortunately, it happens too often.

As much as we’d like to blame former employers, in the end, the IRS sees it as our responsibility to make sure that enough taxes are withheld from our paychecks. That is, of course, unless you filled out the IRS W-4 form and requested in writing to have more withheld from your paycheck.

Fill out your W-4 Correctly

The W-4 has a worksheet on it to help you determine how many “allowances” you should claim. These allowances could be dependents (children, parents who live with you, disabled spouse, etc), and calculations on deductions to income like mortgage interest.

The more allowances you claim on your W-4 the fewer taxes your employer needs to withhold. You can use the IRS Withholding Calculator here to help you estimate more accurately. 

If you told your employer how much to withheld and they didn’t do it, you should appeal to them to pay the difference. But, you’d have to be able to prove that you submitted the information and they ignored it.

You’re Responsible For the Taxes

The bottom line is that we as workers/wage earners are responsible to monitor and pay our taxes. As much as we’d like to blame someone else, in this case, we can’t.

So even if your former employer messed up the withholding, the IRS still requires that you pay the correct amount of taxes. So what can you do?

See if you can get through this without borrowing.

Do you have money in savings?

Could you work extra hours or an additional job until April 15 when the money is due?

Could you sell things on eBay or CraigsList to generate enough cash to make up for the mistake?

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If you owe a huge amount, perhaps you could have a knowledgeable friend or tax advisor help you draft a preemptive letter to the IRS to set up a meeting and work out a plan.

Working before the fees are due gives you much more negotiating power than waiting for them to come after you.

As for the future, definitely, sit down with someone in HR where you work or with a competent tax specialist or account and work out how many exemptions you should be claiming.

When it comes to your paycheck tax withholding, getting a small refund is the goal (somewhere in the $500 – $1200 range). Remember that a refund is not a gift, it’s really money you earned that has been loaned to the Federal Government, tax-free for several months.

On the other hand, you don’t want to cut your exemptions so close that you end up owing money again. So do your planning and watch the amount withheld.

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Taxes for Independent Contractor Work

If you choose to work a 2nd job or do some free-lance work where you’re paid as an independent contractor, please make sure you set aside at least 25 to 35 percent of that money to be paid in taxes.

If you earn more than $600 per year, the company should give you a 1099 form that summarizes your earnings.

As a self-employed worker, you’ll need to pay the full 15.3 percent in Social Security and Medicare Taxes. Plus you’ll also be responsible to pay income tax.

As a paid employee earning wages, your employer normally will pay half of Social Security and Medicare taxes and you’ll pay the other half, but as a self-employed person, you’re responsible for the full amount, in addition to any income tax you may owe. You shouldn’t have any trouble finding some free income tax calculators online. TurboTax has several free tax calculators and tools that you can check out here.

We aren’t accountants or tax experts, so please confirm all of this information with someone who is up to date with the current laws.

One thing we are experts on is utilizing a budgeting system to manage your money and build savings. This would be a perfect time to start using a money management system to get you through this financial squeeze, and then afterward use it to build your financial future.

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