Maybe we’re too preoccupied with the weather or the after-effects of the government shut down, or we’re too excited about the Grammys, or we’re too confused about the new tax law. For whatever reason, the IRS says that Americans have not yet embraced the new tax season with gusto.
Based on the first week of IRS data, just 10 percent of taxpayers have filed, which is 12 percent lower than the same week a year ago. The average refund for the early bird filers is $1,865, down 8.4 percent from last year’s refund amount of $2,035 for the first week of last tax season. While this is preliminary data, it’s worth noting that what might be spooking taxpayers is fear of the unknown.
A NerdWallet Tax Study found that more than 28 percent of Americans “are unsure of what exactly changed with the passage of the Tax Cuts and Jobs Act of 2017, and about half (48 percent) don’t understand how it affects their tax bracket.”
Of course there is bound to be confusion surrounding the new tax code, but the larger problem is that many Americans don’t understand the basic facts of how Uncle Sam levies taxes. For example, people will say, “I’m in the 22 percent tax bracket” and then think that all of their income is taxed at 22 percent, but that’s not how the code works. Income taxes are progressive, which means that as you make more money, the government imposes increasingly higher rates.
Let’s presume that a married couple earns $100,000. They may look at the new IRS brackets and think that they pay a 22 percent tax on their income. But people often forget that the IRS reduces your taxable income by your pre-tax contributions to retirement plans and your deductions (standard or itemized). What’s left is then subject to taxation. The brackets mean that chunks of income are treated differently, so income of up to $19,050 is taxed at 10 percent; $19,051 to $77,400 is taxed at 12 percent; and 22 percent is applied to income of $77,401 to $165,000. In other words, the majority of the $100,000 of income is taxed at 12, not 22 percent.
And if you are entitled to any tax credits, like the Earned Interest Tax Credit, the American Opportunity Tax Credit, the Lifetime Learning Tax Credit, the Child and Dependent Care Tax Credit, or the Savers Tax Credit, those will lower the amount of taxes you have to pay.
When most people talk about taxes, it would be helpful to really understand what percentage of your income you are paying, that’s known as your “effective tax rate.” You can calculate it after completing your return by identifying the total tax you paid for the year, including state and local; and then divide that amount by your taxable income.
And about those smaller refunds. While nearly two-thirds likely saw their tax bill drop in 2018, much of the savings was processed through higher paychecks throughout the calendar year. Last year, Treasury estimated 90 percent of employees would see more take-home pay. That may be the case, but the NerdWallet survey found that just 31 percent noticed the extra dough.
Finally, it always bears repeating that a refund isn’t a tax cut; rather it’s the difference between the amount you withheld and the amount you actually owe. If you do get a big refund, it is not cause to celebrate, because you just extended an interest free loan to Uncle Sam. Adjust your withholding (or quarterly estimates if you are self-employed) to make sure that the money comes to you throughout the year.