What Just Happened With My Refund?

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During the tax season just ended, many of my clients here in Maui were hit especially hard by the ‘Trump Tax Cuts’. Or were they? A comprehensive discussion of the dozens of moving pieces that go into determining the typical tax bill is outside the scope of this post. But here is a simple, plain English inventory of the most important 2018 changes that affect most of my customers.

First, let’s get straight precisely what a tax refund is and why you normally get one. A tax refund is what’s left over after your tax bill has been paid. Your tax bill is the amount of tax you owe on your income. Your refund is the amount of money you gave the government over and above what you owed. I understand that folks enjoy receiving and spending their refunds, but the size of your refund has almost nothing to do (particularly for the 2018 tax year) with the size of your actual tax bill.

Tax Refund Basics:

(all figures in this example are illustrative only, for federal income tax only, and do not include any penalty or interest which might be applicable)

If you make $80,000 a year and have no federal withholding taken out of your paycheck or retirement distributions, and make no federal estimated payments of tax, you would owe around $20,000 in tax So if you had no withholding, and a $20,000 tax bill, you would owe $20,000 at the end of the year.

If you make $80,000 a year and have $20,000 in federal withholding taken out of your paycheck or retirement distributions, or make $20,000 in federal estimated tax payments, you would still have a tax bill of $20,000. But since you had $20,000 in withholding, you would owe $0 at the end of the year.

If you make $80,000 a year and have $25,000 in federal withholding taken out of your paycheck or retirement distributions, or make $25,000 federal estimated payments of tax, you would still owe around $20,000 in tax But since you had $25,000 in withholding, you would get a refund of $5,000 at the end of the year.

It makes pretty good sense when you write it out like that, right? But if you’ve been getting refunds for years and suddenly they got a lot smaller, or perhaps you still owed at the end of the year, that doesn’t mean your taxes went up. It means (generally) that your withholding amount was more accurate.

The 2018 tax reform legislation was written quickly and contains a lot of unintended (and a lot of intended) consequences. One major driver of the change in refund amounts was the major changes made in the withholding tables. Your employer uses these tables to determine the amount of federal tax it deducts from your check and sends to the IRS. These updated withholding tables which went into place for 2018 were actually more accurate than the withholding tables they replaced.

By ‘more accurate’ I mean they deducted amounts that were closer to your actual tax bill.

So if you think about it - you may have gotten a smaller refund (or even owed a bit) - but that doesn’t mean your taxes increased. In fact 90% of all middle income tax payers saw there taxes go down slightly. But since their withholding was more precise, refunds generally were smaller, and fewer people received them.

Over the years a bias for over withholding developed in the system. People got used to it, the government got used to it, and refunds were the order of the day.

Remember, the last time the tax laws changed this fundamentally was in 1986, over thirty years ago. The new tax bill changed some of the bedrock variables in the basic 1040 form.

  • The standard deduction doubled

  • The deductability of state and local income taxes was drastically limited

  • Many miscellaneous itemized deductions went away entirely

  • A more liberal child tax credit was instituted - while at the same time the longstanding “dependency deduction” was eliminated.

And those are only a few of the major changes which affected not only the amount of your tax bill, but the amount of your withholding… and the amount of your refund.

Talk to your HR department and fill out a new form W-4 (withholding statement). They can give you further advice on methods to manage your withholding. And if they can’t . . . I can.