Why High Tax Refunds Are Not As Good As You Think
Last year was the first year that we implemented the Tax Cuts and Jobs Act into our tax training, and many people were surprised to find out that their tax refunds will be lower than usual. However, this does not mean that the new tax laws are bad for your bottom line.
Remember: Refunding large taxes is not always a good thing. In many cases, this means that you gave too much of your money to the government and received nothing but a tax refund check.
Basically, when you get a refund, the government gives you money that you didn’t owe in taxes but paid it anyway (through payroll deductions, quarterly estimated taxes, etc.). Unfortunately, the government does not pay you interest, which means that you could get more money by putting that money into a savings account, invest them and pay the debt for which would be charged interest.
Here’s a 2014 Washington Post video that uses Peeps to explain the concept:
And yes, one of the reasons people like big tax refunds is that getting a lot of “extra money” right away seems more important than getting a slightly higher paycheck every two weeks. It is much easier to think, “I’m going to use my big refund check to pay off the debt,” than to think, “I’m going to use the extra dollars in my paycheck to pay off the debt.”
But the new tax law is designed to increase wages and lower refunds. Here’s a MarketWatch summary of how the Tax and Employment Cuts Act has impacted taxpayers:
The new retention levels have resulted in declines in refunds in 2018 for many. Most of these people actually paid lower taxes for the year, but received less-than-expected refunds after filing their 2018 returns. For many who depend on tax refunds to receive their annual Spring Bonus, the lower than expected refund felt like a tax hike.
You should also be aware that the IRS recently updated the W-4 (this is a form where employees indicate how much tax they want to withhold on each paycheck) to make it easier to understand how much money you are lending to the government in advance. However, this new form is also designed to reduce overpayment of taxes, which means that you may receive even smaller tax refunds in the future.
On the other hand, all these tax changes can lead to an increase in your salary. It’s your job to make sure you use this money wisely.
This story was originally published in 2014 and updated in February 2020.