Despite a smaller refund, you may be a winner of the new tax law
Did your refund go down this year? If yes, you may think that you are paying more in taxes, but your refund is not the right measure to use to see if you are a winner or loser in the new tax law.
First, a bit of background about how refunds work.
In general, a refund is your money that the government keeps and then gives back to you at the end of the year. You give the government money through withholding on your W2 or pension or estimated tax payments. Then at the end of the year, you figure out how much in tax you should have paid and then you get the difference back in the form of a refund.
With the new tax law, many people are getting smaller refunds so they think they are paying more in taxes. However for most Americans, your actual tax liability is lower in 2018 than it was in 2017. Your refunds are lower because you gave the government less money during the year so there is less money to give back to you in the form of a refund.
In 2017, Sally had a tax liability of $1000. She had $1500 withheld on her W2. So, at the end of the year, she received a $500 refund.
In 2018, Sally had a tax liability of $900. She had $1200 withheld on her W2. So, at the end of the year, she received a $300 refund.
So, even though Sally’s refund was smaller, she actually paid LESS in taxes in 2018 than she did in 2017. So, where did that extra money go? She got it during the year in bigger paychecks.
I didn’t change my withholding. Why did it go down?
The next thing many people say is that they didn’t change their withholding at work, so why was there less withholding on their W2? Well, while you were sleeping, the IRS snuck in and changed the withholding tables behind the scenes. So, less money was withheld for federal taxes and more money ended up in each paycheck.
The problem with the IRS sneaking in while you are sleeping is that very few people knew that they had less withholding taken out. So, they really didn’t notice the bigger paychecks AND they thought they were still going to get a big refund at the end of the year.
So, at the end of the day you may be one of the big winners of the new tax bill.. but it sure may not feel like it.