It’s January and you’re starting to organize your documents to file your taxes. The IRS will start accepting tax returns on January 27, 2020 and your employer is required to provide your W-2 by January 31, 2021. Step one: put a calendar invite in early February to block out time to do your taxes. The longer you wait, the more you expose yourself to potential identity theft AND the earlier you get back your money from Uncle Sam.
Will your tax refund be too high?
Generally, we think of tax refunds as a good thing (yay, cash in the bank) and owing the government money as a bad thing, but if you’re getting a big tax return each year, you’re giving the government an interest-free loan on you.
What determines your refund? The government takes (aka withholds) taxes out of your paycheck each time you get paid. If at the end of the year, the total amount they take out exceeds what you owe the government, you get a refund. If NOT, you pay the government the extra you owe. The more allowances that you have on your W-4 (the form that you filled out when you started your job) the less tax is withheld from your paycheck.
SO, getting a big refund or having a big tax bill owed means you probably should be looking at your withholdings.
What counts as a large refund?
Anything over $1,000. When you get a big refund, that means you’re NOT getting that money in your bank account each month (could be $250 / month). This year, I’m expecting to get back over $5,000.
That’s money that I could have been using to hit my savings goals or pay for self care (yoga ain’t cheap), etc. over the course of the year instead of leaving it to the government for 12-15 months. I still have student loans. I could have used that money to make an extra payment on my debt each month. Instead, I’m paying interest to my student loan provider on money that I’m letting the government keep for free. Ugh.
When you should adjust your withholdings
You got a big refund! Some people like to use their refund as a form of “forced savings.” They use the lump sum of cash to make big purchases. However, like I said above, this big refund is coming at the expense of money in your paycheck EACH month. For example, for someone making $100,000, a $3,500 tax refund could translate to $249 per month in extra income if you adjusted your withholdings. Turbotax has a great article with a table that shows you how to adjust your withholdings to get the right amount of extra income in your salary. If you absolutely love the “forced savings” approach, you can use the table to adjust your withholdings to get that big refund check.
If you are single with no dependents like me, you might think that you don’t have a lot of options for adjusting your withholdings but you can actually have TWO allowances and not one. This will keep me from overpaying next year.
You had a “life change” in 2019 (marriage, babies, raises, o my!) If you got a raise, bought a house, had a baby, got married OR divorced, moved to a different state, or started a side hustle that’s generating substantial income – your tax bill will have changed and you may not be withholding the right taxes. Here’s a good overview of life changes to look out for.
Your refund changed substantially from 2018 to 2019 and you are not sure why. Tax reform changed a lot of the rules. The IRS recommended that we all check our withholdings in 2018 after tax reform, but in shocking news, almost none of us did. Nerdwallet has a wonderful guide to all the changes, but here are a few that may have impacted you:
Your tax bracket changed and so did the standard deduction. Here’s a link to the new tax brackets. Remember just because your top marginal tax rate went down doesn’t mean your total taxes did. The standard deduction (what everyone gets to deduct from their taxes irrespective of charitable giving or kids or state taxes) also changed in 2018 going from $12,000 for singles and $24,000 for married couples versus $6,500 for singles and $13,000 joint last year.
Tax breaks for homeowners and people who pay state-income tax got smaller. If you live in California or New York (states with high property tax and high income tax), your tax bill may have been an ouch in 2019. Before the new tax bill passed in December 2017, you used to be able to deduct state income tax & property tax from your federal taxes. Tax reform maxed out both deductions at $10,000. Let’s say your property taxes were $25,000 and your state income tax was $12,750. Starting in 2018, you only got to deduct $10,000 or a $27,750 swing in tax deductions.
Child Tax Credit doubled to $2,000 & now applies to people making over $200K: Under the old law, only joint filers making less than $110,000 in adjusted gross income, qualified for a $1,000 tax credit per kid. Under the new law, joint filers making up to $400,000 adjusted gross income quality, AND it’s $2,000 and $500 for non-child dependents like parents.
The Bottom Line? It’s important that you get your taxes right so you are not under paying owing the IRS a large tax bill. On the flip side, you also don’t want to be loaning the IRS a lot of money for 12-15 months.
Actions this week:
Ask HR how to access your W-4 and check your withholdings (should be in your Peoplesoft equivalent): Your withholdings are determined by what you entered on your W-4 when you started your job. You can download the form from the IRS website or go to your HR or payroll department and adjust it at any time (not just during open enrollment). If not, per above, you could get a big tax bill come April or be trading money that could be in your bank account each month for a big refund (that could make sense for you, but it’s really an interest free loan). It’s too late to impact 2019, but don’t make the same mistake for 2020.
Check your 2018 tax return and compare to 2019. What was your total federal income tax last year and how did it change? Knowing what it was last year can prepare you for this year! If your refund went down, were you getting more money in your paycheck each month? How did you use that money? If your tax bill went up, were you prepared for it or do you need to adjust your spending to cover the higher taxes? Knowledge is power! Take your total taxes paid and divide by your total income – that’s your tax rate. E.g., for me, I switched jobs in 2017 and had a 6-week gap in income. While my total taxes paid went up so did my income (and by more than my taxes). Therefore, my tax rate decreased from 20% to 18%. How did your tax rate change with tax reform? How did your bill change?