Americans getting bigger tax refunds
Experts say refunds are a bad deal, but taxpayers, particularly the young, like receiving an annual windfall. Last year's average refund was $3,003.
This article is by Laura Saunders of The Wall Street Journal.
Three-quarters of all filers will get refunds this year, about the same as usual -- but the amount of those refunds has surged over the past decade.
While the practice of overpaying Uncle Sam throughout the year in order to collect a big refund the next was once sacrilege to personal-finance experts, the rationale is getting more compelling.
Last year's average refund reached a new high of $3,003, and this year's average is tracking last year's, says Internal Revenue Service spokesman Eric Smith. That is almost twice the $1,698 average of 1999. The growth far outstrips inflation.
A close look at tax data shows the growth in refunds hasn't been confined to taxpayers at any one income level, says economist Roberton Williams of the Tax Policy Center in Washington. Some people who suffered job or investment losses in the 2001 or 2007-09 recessions did overpay inadvertently, and received bigger refunds, but these increases don't explain the total rise.
The past decade also brought new or short-lived tax benefits for which taxpayers may not have adjusted their withholding, Williams notes. Examples include the American Opportunity education credit; two of the three home-buyer credits; and the expanded child credit.
But nontax factors likely came into play as well. The conventional wisdom used to frown on large tax refunds, because they amounted to an interest-free loan to the government and reduced investment capital by the same amount. Better, it was thought, to have the money upfront and invest it, or else let it earn interest.
Yet over the past decade the opportunity cost of big tax refunds fell sharply. Interest rates plunged to multi-decade lows, while the stock market stagnated. (In three of those years it fell, making some poorer for their efforts.) Meanwhile, with incomes for many people growing only modestly, the notion of a big lump-sum payment grew more appealing. It was like a bonus, in a smoke-and-mirrors kind of way.
Research by behavioral economists shows that even though money is fungible in theory, it isn't in practice. "To most people, a $3,000 check feels very different from $3,000 dribbled out in paychecks over a year," says Nicholas Epley, a psychologist at the University of Chicago's Booth School of Business.
You can see the old and new conventional wisdom clash in the attitudes held by different groups of Wall Street Journal readers: younger taxpayers who welcome large refunds, and older ones who don't.
"We try to be withheld to within $100 of our actual tax," says Wes Schultz, 70, a retired financial executive from the Milwaukee area. But he has younger family members who overwithhold on purpose. "One of them earmarks his refund to pay next year's property taxes and replenish his emergency cash supply," he says.
Daniel Farrar, a 61-year-old retired payroll professional from Canton, Ohio, agrees: "We never plan on a large refund, and don't earmark it." Nevertheless, he'll get a check for nearly $5,000 from the IRS this year because he unexpectedly claimed his daughter, who finished college in 2010, as a dependent and also took her American Opportunity Credit. A chunk of it will go into a Roth IRA, he says.
Dara Rosenberg, a 24-year-old actress in New York, sees refunds very differently. "I don't know why everyone hates tax season," she says. "I look forward to it." She tries to overwithhold all year long in order to ensure a larger refund; this year, it will be $1,600. Rosenberg reserves part to pay veterinarian bills for her bulldog, Truman. "I count on that every year," she says.
If your own refund feels too big or small, the bad news is that changing it often means an encounter with the IRS's W-4 form, which employers use to figure paycheck withholding. Although the form itself has only 10 blanks, filling them can involve grappling with three worksheets and two tables.
The W-4 is a challenge even for people familiar with the 1040, says Jackie Perlman, an expert with H&R Block's Tax Institute. "A withholding allowance isn't the same thing as an exemption, and filing status is confusing as well. It's intimidating."
The upshot, she says: "If you don't feel comfortable doing your own taxes, don't try to do your own W-4."
The good news? If you pay for tax preparation, there is usually free help with the W-4. Many accountants offer it, says Melissa Labant of the American Institute of CPAs. H&R Block also will do a W-4 without charge for customers, and Turbotax products have a W-4 feature. The IRS also offers a withholding calculator at http://www.irs.gov. For best results, approach them all with a paycheck and your tax return in hand.
More from The Wall Street Journal and MSN Money:
It makes sense most young people aren't savvy about money and understand what they are doing. They look at it like a paycheck and aren't disciplined enough to take that amount per paycheck and use it for the purpose they planned all along.
I typically have problems with my total tax amount due since my wife is self-employed and her earnings swing wildly every year. The one thing I do know is I defintiely don't want to owe come tax day this year it worked out pretty well.
How is it even possible to withhold accurately with the tax laws changing near the end of the year? If the tax laws hadn't been changed I would have been hammered by the AMT and would have owed taxes. Once they passed the extensions of the tax reductions, I got a refund. The best I can try for is to withhold 100% of the taxes paid last year (or 110% for those with higher income) so I can be sure to avoid a penalty. Unfortunately even targeting a fixed withholding is pretty much impossible for me. I'm a salaried employee, but I get a significant portion of my income from bonuses and stock options. Since I can't count on how much I'll get from those sources, I target 100% based on withholding from my normal paycheck, but when I get a bonus or sell stock options, the IRS requires that my employer automatically withhold 25%, so that causes me to withhold significantly more than the previous year's tax bill. It's been a good year so far. I already have more withheld for 2011 than my 2010 taxes. I've cranked my allowances up to limit additional withholding for the year, but I'm pretty sure I'll still have a refund.
This is the first year I've gotten a refund in quite a long time and I love it! Do I care that I could have kept just that little bit more during the year to "invest"? Hell, no. Give me that big check!
If Uncle Sam manages to squeeze a little more revenue out of keeping my money for a while, what do I care? Sounds like he needs it these days.
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