For many Americans, tax season is a bit of a double-edged sword. On one hand, Americans have to deal with the tax-preparation process, which, if you itemize your tax deductions, or if you're self-employed, can be quite cumbersome.
The Internal Revenue Service (IRS) estimates that taxpayers spent 8.9 billion cumulative hours complying with federal tax laws in 2016. Mind you, these tax laws now work out to more than 10 million words, with an average of 144,500 words being added per year since 1955, per the Tax Foundation!
But tax time is also like a second holiday season for nearly three in four taxpayers. Data from the IRS shows that 73% of taxpayers received a federal income tax refund in 2015, with the average refund amounting to more than $3,100. That tidy sum of cash could be a means to paying down credit card debt, bolstering up an emergency fund, or padding a retirement account. The fact that most taxpayers net a refund from the federal government is, perhaps, the main impetus for most Americans to do their taxes.
Income tax refunds have fallen off a cliff in early 2017
However, an interesting trend has emerged in early 2017 that might be catching taxpayers off guard. According to IRS data of tax-filing statistics, for the 2016 calendar year through Feb. 3, 2017, the total number of tax refunds issued had fallen by 62%, while the net dollar amount in refunds issued crashed by 78%, to $13.15 billion from $58.63 billion in the previous year over the same time frame. The average refund is down, as well, by 41%, to $1,994 as compared to $3,385 last year.
So what gives?
A little bit of the blame could be targeted at a 24% decline in the number of returns received through Feb. 3 (just 20.18 million this year compared to 26.67 million last year). It's possible that taxpayers are (incorrectly) holding out hope that tax laws are changed by President Donald Trump before they file their taxes.
But the bulk of the blame relates to a recently passed law, known as the Protecting Americans from Tax Hikes Act, or PATH. The PATH Act requires the federal government to withhold a taxpayer's entire federal refund until at least mid-February if, as an individual or family, the taxpayer is eligible for the Earned Income Tax Credit (EITC) or the Additional Child Tax Credit (ACTC). Please take note of the added emphasis in the previous sentence because it means that, no matter how large or small your refund, if you qualify for the EITC or ACTC, your entire refund will be held up for a few weeks.
The purpose behind the PATH Act
The reason the PATH Act even exists is because the federal government is trying to crack down on fraud associated with the EITC and ACTC. Based on estimates from the IRS, between 21% and 26% of EITC claims are paid in error each year.
In 2015, some $15.6 billion in erroneous EITC payments were paid out, according to the Treasury Inspector General for Tax Administration. While the IRS is realistic about its efforts to reduce fraudulent activity, the nonpartisan congressional Joint Committee on Taxation estimated that the delay, which allows the IRS extra time to match-up W-2s with tax filings, would increase federal revenue by $779 million over the next decade.
The EITC, which is a credit given to hard-working low-income families, is a particularly big concern for the IRS because as many as 7 million people annually aren't aware that they qualify. The reason is that some taxpayers believe that if their tax liability has been reduced to $0, they no longer have a need to file a tax return.
However, as my Foolish colleague Maurie Backman recently pointed out, the EITC is a fully refundable credit: Even if your tax liability is lowered below $0, you'll get a federal refund for the difference. Until there's a better understanding of who qualifies among low-income individuals and families, thieves will continue to exploit taxpayers' ignorance. It's the IRS's hope to stop as much of this fraud as possible.
As a result, tax refunds that would normally be sent out in January and early February for lower-income folks who usually receive the EITC or ACTC are probably going to be pushed into late February and March. It's also possible this shift in tax refunds could impact the retail industry, which typically relies on a boost in after-tax discretionary spending beginning in January.
One tax move to make in 2017 and beyond
If you're one of the tens of millions of taxpayers due the EITC or ACTC, there's not much you can do about the waiting process. However, there is a smart tax move you can implement in 2017 and beyond to potentially pad your pockets.
Most of the taxpayers who are eligible for the EITC and ACTC are likely going to get most of what they pay in federal taxes back, with the exception of FICA taxes. Yet most of the taxpayers receiving the EITC or ACTC probably aren't adjusting their tax withholding throughout the year to their benefit.
In other words, instead of receiving a large refund in addition to the EITC or ACTC, taxpayers can lower, or eliminate, the amount taken out of each paycheck by the federal government by adjusting Form W-4, the tax withholding form. Over the course of the year, taxpayers will receive a larger weekly, bi-weekly, or monthly paycheck, which may help ease the burden of having to wait longer for their refunds.
Plus, adjusting your tax withholding is just smart. The federal government doesn't allow taxpayers to earn interest on the money they owe you, so it's typically not a smart move to allow the government to keep your money and pay you a large refund check come April.