Stop browsing the travel sites for late-winter getaways. Stop eyeing up new 72-inch televisions or the lease on a new car.
If you’re one of the tens of millions in line for a big tax refund check this season, there’s one other step you should think about taking before you spend a dime: Review Form W-4 filed with payroll at work.
That form tells your employer how much tax to deduct from every paycheck. If you’re getting a big refund, the chances are you overpaid last year’s taxes. And if that happens every year, you might want to cut the amount of taxes withheld from every paycheck.
“If you’re getting a big refund, and you would like some more take home pay, you need to sit down with the W-4 worksheets,” says Jackie Perlman, principal tax research analyst at H&R Block’s HRB, -7.56% Tax Institute. In other words, you may want to reduce your withholdings, the amount of money that’s held back to pay your taxes every year.
People getting refunds “effectively gave the government an interest-free loan for use of the money,” says Melissa Labant, director tax policy and advocacy at the American Institute of CPAs. Of course, many workers are already aware of that. “Some people prefer and actually rely on receiving a refund each year,” she said. “It is an indirect way of saving.”
Someone getting a small tax refund probably isn’t going to care. Ditto someone who is flush with cash or who likes having a refund to treat themselves to that vacation after the holidays or, indeed, someone who doesn’t want to spend a lot of time on Form W-4 calculations.
On the other hand, a majority of U.S. households lack access to ready cash. About 60% have less than $1,000 in savings, according to two recent surveys. Many more people are carrying credit-card debt from month to month, often at interest rates of 16% or more. Americans collectively owe more than $1 trillion in credit-card debt and $1.5 trillion in student debt. For them, lending money to Uncle Sam makes no sense – let alone at 0% interest.
The sums involved are not trivial. The average tax refund was $2,900 last year. Nearly three quarters of U.S. taxpayers got a refund check last year, the IRS says. The total amount sent out: $325 billion.
But not all of that is overpayment, warns Caroline Bruckner, managing director at the American
University’s Kogod Tax Institute. Many low-income workers get refunds way in excess of any tax they actually paid. That’s because of the Earned-Income Tax Credit and the Child Tax Credit. Both credits are “refundable,” meaning you can get back more than you owe in tax.
According to Congressional Research Service calculations, at the last count those credits made up about one quarter of the total refund bill.
The situation is unclear this year because of dramatic changes to the tax code made by President Trump’s 2017 tax reforms. The American Institute of CPAs warns that many taxpayers may find they have withheld too little.
The calculations can be complex. If you end up withholding too little, and underpay your tax, you’ll owe interest at an annual rate of 5%. The IRS calls that a “penalty,” but it’s actually a much cheaper loan than many other sources of emergency funds.
If U.S. workers are lending money to Uncle Sam at 0% interest, and then forced to borrow money from a financial institution at anywhere from 10% to 32% interest — according to calculations by personal-finance site Value Penguin depending on their credit score — they’re two-time losers.