On ABC News yesterday morning a report came out that some people were angry over their shrinking tax refunds. And it was also reported that others were outraged because they had to unexpectedly pony up extra cash to pay Uncle Sam.
I was surprised by this and have some thoughts on the matter that I’d like to share.
Understand that I have no desire to debate whether or not the Trump tax cuts were good or bad for the country, and whatever your belief is I respect it completely – especially where I’m mostly apolitical. In fact, the discussion of politics in general drives me absolutely nuts, and I’d much rather spend my time focusing on…I don’t know….ANYTHING else!
However, I am putting the topic out there so feel free to use the comments section below if you want to discuss/debate the tax issue amongst yourselves. I’ll never interfere with free speech and I value all of your opinions.
Now that I’ve cleared the deck on where I stand politically, allow me to explain what happened to your taxes and why for most part this isn’t a bad thing.
It all started with the lowering of the tax brackets –
When the tax cuts were passed the Internal Revenue Service (IRS) lowered the tax brackets which resulted in shiny, brand new tax tables. These tax tables can be found easily by typing “2018 Tax Table” in Google. It’s not rocket science. I would put the tax table here, but you can find this info everywhere so I’ll spare you the boring nonsense.
Most of us saw a small raise –
The IRS changes to the tax table caused most paychecks to see a small, but meaningful increase in pay (think raise) because the IRS is now taking out less taxes. For example, Mr. FE saw an increase of $36.00 in his weekly paycheck increasing his yearly income by $1,890, or approximately $157.50 per month.
If you got a smaller or no tax refund at all –
One reason your tax refund may be smaller, or disappeared altogether, is the fact that most people did not make adjustments to their W-4 or tax withholding resulting in a smaller refund, or possibly even a tax owed.
But before you run off to make changes to your W-4, it’s best to do some quick math first. The IRS has this handy-dandy tool that nobody seems to use. This tool can tell you if you are withholding too much, hence a sizable refund, or withholding too little, hence money owed to the big bad wolf. It’s called a “withholding calculator” and it’s paid for by you, the taxpayer.
Whenever Mr. FE gets a pay raise, I run the withholding calculator to see if we need to make adjustments. It’s a very valuable little tool.
It’s not necessarily a bad thing if you get a lower refund because this means that you didn’t overpay on your taxes this year.
Now what happens if you make the necessary adjustments to your withholding and you still get a smaller refund, or (gasp!) owe more green stuff when the tax man cometh?
If you were side swiped by the new credit/deduction changes –
The new tax code increased the standard deductions, while reducing or eliminating other key credits and deductions. So even those who may have adjusted their W-4 after the tax overhaul could still see a significant difference between this years tax return and prior tax filing years; especially if you itemized.
If Mr. FE and I owed on our taxes I would still file our tax return on time even if we couldn’t pay up (we would pay what we could). In my personal opinion, it’s not worth the tax penalties we would incur. Rather than delay the inevitable, I would work with the IRS to see if I could hash out a repayment plan, and try to avoid filing an extension knowing it would do little to dig us out of our hole.
Depending on your personal situation it may be worth consulting a CPA or certified tax consultant for advice. Unfortunately, as with everything in life there is no such thing as one size fits all. The new tax code should benefit most, but not everyone.
This year our own personal return was reduced by about 14.79%, but we still received a tiny refund. We hit the sweet spot!
Why Tax Refunds Are Overrated Anyway –
If you received a tiny tax refund or none at all, you hit the sweet spot. Do a happy dance! You got to keep most of your money throughout the year to invest wisely instead of forking it over to Uncle Sam.
Well, allow me to prove my case by setting the stage between you, your favorite barista, and little bank I’ll call Starbank.
You stop in for your usual loca mocha coco java drink thing and you decide to hand the barista an extra $5.00. You ask this kind and wonderful barista to add this $5.00 to your Starbank account. You explain that you want this deposit held until the following year for when you are allowed to come back to collect it.
Congrats! You just made your first official deposit to Starbank.
Now, every single morning you stop in for your caffeine fix you give the barista another $5.00 to deposit into your Starbank account. In the meantime, Starbank is free to do whatever they want with your money, like earn interest.
It’s now a year later and Starbank’s now holds a whopping $1,825 worth of your hard-earned green stuff in their account, plus interest, bringing the total amount to $1853. So you fill out your withdrawal slip and Starbank hands you back $1,825, while they pocket the extra $28 for themselves. Cash they earned off of your money.
Sound like a great deal?
NO! ABSOLUTELY FREAKIN’ NOT, I tell you!
So why is it different if we give the same $1,825 to the IRS to hold for us all year, interest free?
Think of IRS like you would your barista.
Let’s take another look at the compound interest –
Now lets’ factor in the compound interest you could have received if you invested that $5.00 per day yourself instead of giving it to the IRS to hold. We’ll take that same $1825 and compound it daily at a modest 3%. This would produce a return of $1853 yielding you a return of an extra $28 in compound interest earned.
Not much you say?
Now let’s take that same $5.00 a day or $1825 per year and invest it for 5 full years at that same modest 3%. You would end up with an astounding $12,095.53! That’s over $2970.23 extra in your pocket in compound interest just for not handing your hard-earned cash over to Uncle Sam.
Trust me on this, be your own barista!
Did you see any significant changes to your taxes? If so, what are your thoughts?
Add On Disclaimer: I am not a qualified tax or financial professional and this post is for informational and entertainment purposes only. I only wish to share my personal opinion on the topic of taxes. Any changes you make to your taxes are your responsibility. It’s best to consult a qualified tax or financial professional if you are in need of advice or assistance. Please see full disclaimer below or click here.