As the April days tick down toward this year’s tax deadline, more Americans might find their refunds are substantially different from previous filings because of the 2017 tax overhaul that took effect this year.
The new law eliminated the personal exemption and lowered a number of other popular deductions, including mortgage interest and state property tax deductions. On the other hand, it doubled the standard deduction and reduced the tax brackets across the board.
Whether or not those changes end up reducing most Americans’ total tax burdens throughout the year, as Republicans have said, or benefit mainly to the rich, as Democrats argue, they are likely to alter millions of Americans’ refunds.
To account for the new tax law, the Internal Revenue Service adjusted its guidance for businesses on how much taxes they should withhold from employees’ paychecks based on their total income and how many dependents they have. Still, many Americans are likely to find the adjustments do not account for other parts of their finances such as the size of their mortgage or what they earn from investments, resulting in a higher or lower refund than they are used to.
A report from the Government Accountability Office last summer estimated millions more Americans would have to pay up this year. It predicted 21 percent of taxpayers had withheld too little in taxes from their paychecks in 2018. According to the report, that percentage of American taxpayers was an increase from what it would have been — 18 percent — if there was no tax overhaul.
The final numbers won’t be available until after the April 15 filing deadline, but early estimates from the Treasury Department show the average 2018 refund was slightly higher than the previous year. But that could be because people who know they are getting a refund tend to file their taxes earlier and they want their money quickly, whereas people who know they will have to pay tend to file later in an attempt to stave off paying a long as possible.
If you’re the one in every four Americans that doesn’t get a refund, here are some reasons to take solace, plus ways to fix that for next year.
Should you want a large refund?
When people get a refund, it means they have overpaid taxes to the government.
From a purely financial standpoint, this is not beneficial to the taxpayer because they are essentially giving the government an interest-free loan until they reclaim their money during tax season. Because of inflation, the money is probably also be worth less in April than the year before.
But getting a tax refund feels so good, doesn’t it?
“People literally get a euphoria because they forgot about that money,” said Damon Jones, an associate professor at the University of Chicago who focuses on tax policy, household finance and behavioral economics.
Unfortunately, your pocketbook doesn’t feel the same euphoria. Research shows taxpayers see their refunds as a windfall rather than a reimbursement of their hard-earned money, and that means they are more inclined to spend the money than they would have been if they received it in their regular paychecks.
But there are logical reasons to want a refund rather than being required to pay at tax time. First, the government will penalize you if you pay too little during the year.
The IRS typically charges a penalty if Americans do not pay at least 90 percent of the taxes they owe through their paychecks during the year. (As with many tax issues, how much the penalty is can be a bit complicated, but most tax programs will calculate it for you.) This year, however, the agency said it is lowering the threshold to 80 percent to give taxpayers more relief as they work through the law changes.
The threat of any kind of a penalty is enough for most people to want to err on the side of overwithholding. It’s part of an economic and psychological theory known as loss aversion — people are more afraid of potential losses than they are excited about potential gains.
The losses are particularly daunting for lower-income Americans who likely do not have a tax attorney to handle any issues that might arise.
“It is sensible if you are low-income that you want to be on the safe side,” Jones said.
An analysis by ProPublica last year showed people who receive the earned income tax credit — a benefit for low-income working Americans — are twice as likely to be audited as taxpayers with incomes between $200,000 and $500,000 and they were more likely to have their refund held while the IRS double-checked their paperwork.
Some Americans also treat their tax refunds as a kind of savings. By taking out more money from their paychecks each month, they keep themselves from spending it. Then, when they get their refunds in April, they have a sum they can spend on a larger purchase.
One caveat about that approach: 27 percent of Americans plan to use their refunds to pay down debt, according to a survey from GOBankingRates. In that case, it would have been better for those taxpayers financially to withhold less from their paychecks so they could pay off their debt earlier in the year and avoid the interest or use it avoid incurring as much debt in the first place.
How to adjust your tax withholding
Americans should revisit their withholdings every year, said Lisa Greene-Lewis, a tax expert for TurboTax. Life changes such as marriage, children or buying a house can substantially change what a person owes in taxes, so it is important to make sure what is being withheld from each paycheck is in line with what you owe in taxes.
It’s mostly done through the W-4 form, which taxpayers can revise and submit to their employer at any time.
Here’s a guide from Investopedia for how to fill out the W-4. Greene-Lewis said there are also online calculators that can help taxpayers approximate what they will owe in taxes. Taxpayers can get assistance from their human resources departments, and there are a number of free services for low-income individuals.
Allowances depend on whether a person has a working spouse and children. People with side jobs might also want to calculate their withholdings differently than those with a single source of income, Greene-Lewis said. They might want to withhold more money from their larger paychecks if their second job does not subtract taxes, for example.
The more allowances a worker marks down, the less tax their employer is going to take out of their paycheck, and for better or worse, the smaller the tax refund come next April.