It's officially that bittersweet time of year again: tax time.
I can't personally say that I know anyone who enjoys scouring through receipts and their personal financial history from the previous year, but for many American taxpayers tax season also brings with it a late holiday gift -- a refund from the U.S. Treasury Department. In 2014, based on data provided by the IRS, some 147.4 million individual tax returns were accepted, of which 118.7 million qualified for tax refunds. Or, of the nearly $3.1 trillion collected by the IRS, about $373.5 billion wound up being returned to taxpayers.
States where average tax refunds are highest and lowest
As you might imagine, the amount of a tax refund can vary wildly based on a number of factors, such as income, deductions, and even the state a taxpayer lives in. Courtesy of data from Debt.com, we've been given access to which states in 2014 offered the heartiest average tax refunds, and which states generated the most anemic average tax refunds.
Leading the pack in terms of highest average tax refund were the following states:
- Connecticut: $3,126
- Texas: $3,033
- New York: $2,963
- New Jersey: $2,959
- Mississippi: $2,944
Why these states? It's impossible to say with any concreteness, but it's possible that higher average incomes in Connecticut, New Jersey, and at least some portions of New York relative to the rest of the nation could result in households overpaying their federal income taxes throughout the year.
For Mississippi it's the exact opposite. With the lowest average median household income in the nation, Mississippi taxpayers are likely receiving substantial refunds on account of tax credits targeted at helping low-income and moderate-income families, such as the Earned Income Tax Credit and Child Care Tax Credit.
On the flipside, the states sporting the lowest average tax refunds were:
- Vermont: $2,254
- Maine: $2,277
- Montana: $2,299
- Wisconsin: $2,329
- Oregon: $2,330
Vermont is one of the least tax-friendly states in the country, taxing retirees' Social Security benefits without any exemptions, imposing a 6% state sales tax (which local jurisdictions can add up to 1% to), and adding a state income tax of 3.55% to 8.95% depending on an individual's or family's taxable income. There's simply not as much left over when Vermont is through with its taxpayers.
As for the other states, the reasons vary greatly. In Oregon, consumers pay the nation's top state-level income-tax of 9.9%, whereas Montana tends to hit its retirees especially hard with taxes on most forms of retirement income, including Social Security (albeit with some income exemptions).
The refund fallacy
Yet, there's an irony to the above figures. Vermont, Maine, Montana, Wisconsin, and Oregon may be bringing up the caboose when it comes to average tax refunds, but they're actually leading the pack when it comes to taxpayers using their income wisely.
If you're like most Americans, you're probably not a very good saver. Data from the U.S. Bureau of Economic Analysis in December shows that personal savings rates are only 5.5%, which pales in comparison to other developed countries, such as Germany and France. American taxpayers have thus come to rely on a federal tax refund as a way of forcing themselves to save -- and retailers like Wal-Mart have come to count on these refunds to drive discretionary spending, such as on new electronic devices.
But there's a fallacy about a tax refund: you're not actually saving yourself money so much as costing yourself opportunities over the long run.
You see, the federal government is essentially borrowing money from you for a period of a few months to perhaps more than a year without having to pay you a single cent in interest. As long as the inflation rate is positive -- and history shows us it's positive far more often than not -- the money you're getting back from the federal government, money that should never have left your paycheck in the first place, is now worth less. This is money you could have used for investment purposes, or to pay off interest-bearing debt over the past year.
But there's a simple solution: adjust your tax withholding status.
Form W-4 is the means by which you can make simple adjustments to the amount of tax you want withheld per pay period, or claim exemption from taxation should you so choose. Before adjusting your withholding status you should have a good understanding of your annual income and be able to estimate how much federal tax you'll be estimated to owe in a given year.
Generally speaking, if you wind up owing more than $1,000 to the federal government at the end of the year you could be penalized. Of course, if they owe you, you're missing out on opportunities to improve your financial situation. So your goal should be to get as close to a $0 refund as possible without tipping the scale too far in one direction or the other.
Best of all, a W-4 can be altered throughout the year, so it's not as if you're stuck with your selection. I can personally recall claiming federal tax exemption for three months out of each year when I was much younger, as I knew I would be due a hefty refund and preferred to have more of my paycheck upfront so I could put that money to work paying down debt.
I know you probably want as big a refund as possible this coming tax season and beyond, but do yourself a favor and stop allowing the federal government to hang onto money you've earned. You deserve to be putting your money to work right now, and not a year or more from now.