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Overpaid Tax – What Happens To Overpayment of Taxes?

Overpaid Tax – What Happens To Overpayment of Taxes?

Overpaid TaxOverpaid tax amounts to an interest-free loan to the IRS. Normally, an overpayment of taxes is refunded automatically when filing your taxes.   There are some common things that often lead to overpaying taxes.  Maybe, you are better off avoiding them. Sometimes, Americans make mistakes on their taxes and accidentally end up paying more than they should. In that case, taxpayers can reclaim overpaid income taxes by filing an amended tax return.

Every year, millions of taxpayers overpay their income taxes.  Often to the tune of hundreds or even thousands of dollars. In total, this amounts to billions of dollars in overpaid taxes.  In 2021, an estimated 16 million people overpaid taxes by an average of about $1,200 due to a change in how unemployment benefits are taxed. By November, the IRS had refunded more than $14 billion to people who overpaid taxes.

To date, the IRS has issued over 11.7 million refunds totaling $14.4 billion. This latest batch of corrections affected over 519,000 returns, with 430,000 taxpayers receiving refunds averaging about $1,189. (Source: irs,gov)

Within 30 days after the adjustment, affected taxpayers will normally get letters from the IRS.  The notice will advise them of the type of adjustment made and the amount of the adjustment.  For example, a refund, payment of IRS debt payment, or payment offset for other allowed debts.

Overpaid Tax – Why Cautious Taxpayers Overpay Taxes

It’s understandable to be cautious when it comes to setting withholdings and paying your taxes. For some, this means starting their tax preparation and filing their returns early.  Filing early in the season can prevent a last-minute scramble as the tax deadline approaches. Some taxpayers purposely overpay taxes through withholdings on their paychecks. Overpayment of taxes can provide peace of mind if you are afraid that your calculations are incorrect.  These taxpayers deliberately choose to increase their withholding amount to be on the safe side.  In their opinion, it’s better to overpay a bit than owe interest or penalties.

IRS Underpayment Interest Charges

When you fail to pay your tax, fines, additions to tax, or interest by the due date, the IRS assesses underpayment interest. Even if you file an extension, the underpayment interest will still apply.

We charge underpayment interest when you don’t pay your tax, penalties, additions to tax, or interest by the due date. The underpayment interest applies even if you file an extension. If you pay more tax than you owe, we pay interest on the overpayment amount. Underpayment and overpayment interest rates vary and may change quarterly. Changes don’t affect the interest rate charged for prior quarters or years. See Quarterly Interest Rates for more information. (Source: irs.gov)

Overpaid Tax Refund – A Clear Sign You’ve Overpaid

The amount of your refund is the most evident indicator that you are paying too much tax. The average refund for people who file early in the filing season is over $2,000.  Taxpayers tend to file earlier when they know they have a refund coming. Moreover, overpaid tax is understandable given changes that can happen later in the tax year. For example, a child may be born, a job may be lost, or a dependent may move into the household.  Often, the taxpayer may not have had sufficient time to modify withholding amounts. If you get several thousand dollars back year after year, you are obviously overpaying your income taxes.

Common Causes for Overpayment of Taxes

Common life events can cause the amounts you should be withholding to change. The following are the most typical events that influence the amounts that should be withheld from your paycheck:

  • Marriage – If your spouse earns a salary, it may affect your household’s tax bill. If your spouse is dependent, your withholding amounts could be reduced.
  • Divorce – Dissolution of marriage definitely has an impact.  This necessitates an update, especially when dependent children are involved.
  • Adding a dependent – The birth or adoption of a child reduces the amount you should be withholding. This is because you are adding a dependent for whom you are financially responsible.
  • Changes in income – You usually end up owing the government more if you get a raise or engage in a side hustle for a second income. You should increase your withholding to reflect additional income.  If your wages drop or you curtail your side hustle, then the excess withholding amounts can be eliminated.

Sometimes, your company’s payroll department may be aware of life changes like marriage or the birth of a child.  As a result, they may encourage you to update the W-4. However, most times it is up to the individual to update the withholding information through their own initiative.

Overpaid Tax – Adjusting Withholding

When you anticipate a substantial tax credit or deduction, it makes sense to reduce your withholding. The longer you wait for the money, the higher the opportunity cost. In addition to life events like marriage or childbirth, there are other items that affect withholding amounts.  For example, there are education credits, dependent care credits, charitable giving deductions, and other items.  These can all be converted to withholding reductions utilizing IRS worksheets and guidelines. Why wait to modify your W-4 for the coming year?  You can use the IRS’s own withholding calculator to run various scenarios right now.

To change your tax withholding amount:

  • IRS Form W-4 – Enter your new tax withholding amount on Form W-4, Employee’s Withholding Certificate. Complete Form W-4 so that your employer can withhold the correct federal income tax from your pay. Consider completing a new Form W-4 each year and when your personal or financial situation changes.
  • Submit to your employer – Ask your employer if they use an automated system to submit Form W-4. Submit or give Form W-4 to your employer

To keep your same tax withholding amount:

  • No action required – You don’t need to do anything at this time.
  • Check and update yearly – Check your withholding again when needed and each year with the Estimator. This helps you make sure the amount withheld works for your circumstance.

What Happens If You Overpay Your Taxes

Most often, when you overpaid your taxes, the IRS will simply refund you the difference. The IRS typically takes three weeks to process and distribute refunds. If you would rather not receive a refund, you can choose to pay ahead for the following year’s installments.  Simply apply the excess to your taxes for the following year.

What if you made an overpayment of taxes by mistake or missed a deduction you are entitled to?

Often, taxpayers discover later that they overlooked a deduction or credit that could have reduced their tax liability.  Or, the deduction or credit might even have resulted in a refund. In that case, you can still get your money back by completing an amended return within the timeframe allowed. Every year, the IRS processes millions of returns. If they discover math or clerical problems when reviewing your return, they will usually correct them automatically.  In that case, you will not have to file an amended return.

Underpaid and Overpaid Tax – Amending Tax Returns

An amended tax return is just a correction to a previously filed tax return. It permits you to recover any money you overpaid.  For example, as a result of missing a tax deduction, or credit, or making a math error the IRS did not catch. However, filing an amended return is not the same as filing your regular 1040 tax return. You must file Form 1040-X. Mark the tax year you’re amending and explain why you’re doing so.

The 1040-X has three columns. Column A displays your original figures while Column C displays your updated figures. Column B displays the difference between A and C. On the reverse of the form, you can describe your modifications. For instance, whether you are owed an additional refund or must pay additional taxes. You must also submit your original 1040 form with your submission.

In general, you must amend your return within three years of the original due date. Also, if you’re claiming an additional refund, don’t file your amended return until you’ve received your original refund.

Up Next: IRS Letter 2645C – What It Means

IRS Letter 2645CIRS Letter 2645c is an interim letter from the IRS saying they need more time (45-60 days) to review the documents or information you submitted.  The Internal Revenue Manual refers to them as “interim letters” (IRM 4.19.23). The letter merely states that the IRS has received something from the taxpayer but has not yet acted on it.

Normally, a taxpayer receives IRS letter 2645C because the taxpayer previously contacted the IRS to resolve a matter. The IRS has received the information but the information has not been processed yet. However, the IRS is required to notify taxpayers in the event of a delay.  IRS Letter 2645C serves as a notification advising more time is required to process your information.  Usually, the delay is 60 days.

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