We're officially nearing crunch time. There's now less than one month to go before your 2016 calendar year federal taxes are due.
For many Americans, tax time is bittersweet. On one hand, it means poring over copious amount of receipts and having to revisit our financial dealings from the prior-year period. Making matters more difficult, federal tax laws seemingly change all the time. In the period between 2001 and 2012, nearly 5,000 tax law changes were made on Capitol Hill, and since 1955, the U.S. tax code has added an average of 144,500 words per year. The U.S. tax code now stands at more than 10 million words, according to the Tax Foundation. Even with the aid of a tax professional or software, it makes preparing your taxes somewhat daunting.
On the other hand, tax time is a personal treat for more than 70% of tax filers. In a given year, more than 70% of federal tax filers will get a refund from the government. Considering that our economy is heavily swayed toward consumption, this added capital can spur discretionary purchases, as well as allow consumers to pay down debt created by discretionary purchases during the holiday season.
Just how much money are taxpayers getting back in a given year? Let's take a look.
The average American's tax refund over the past decade
Below, courtesy of tax refund data from the IRS and 20SomethingFinance.com, you'll see the average American's federal tax refund by year over the past 10 years. Keep in mind that this data includes the tax filings this year based on IRS data through March 3.
You should also note that the year axis below represents the point at which the average American received their refund. The actual refund is based on the prior year's calendar taxes. Thus, the 2010 average refund of $3,003 is based on taxpayers' 2009 calendar year tax return.
With the exception of the partial year data we have for 2017 through March 3, there appears to be a slight downtrend in average tax refunds since the Great Recession years. What's the cause for this drop in average tax refunds? Chances are, it probably has to do with economic growth and a modest increase in consumer incomes since the Great Recession. If people are making more, their tax liability would presumably be higher, thus resulting in a lower average tax refund.
Nonetheless, netting between $2,651 on the low end and $3,036 on the high end would certainly move the needle if you're looking to bolster an emergency account, pay down debt, or add to a retirement portfolio.
The average American is making a big tax mistake
Unfortunately, these average tax refund statistics also expose a pretty deep flaw among Americans: the idea that a large federal tax refund should be the goal. In actuality, allowing the government to keep your money without paying you a cent in interest is a terrible move on your part. The real goal should be to get as close to $0 owed/refunded as possible.
The easiest way to ensure that you get more of the money you're due up front is by adjusting Form W-4, which is officially known as the Employee's Withholding Allowance Certificate.
In plainer terms, the federal government doesn't get to decide how much of your income to withhold. The amount of federal income tax withheld is determined by you. If you're due a fat refund from the federal government, you can reduce what they take out of your weekly, biweekly, or monthly paychecks by adjusting your W-4. Similarly, if you'll owe a lot at the end of the year, you can increase your tax withholding and reduce or eliminate your tax liability.
Now, some of you are probably thinking that it really doesn't matter whether you get an increase in pay spread out across all of your paychecks or you get a tax refund come April of the following year. However, it does matter. If you're planning to invest your money or use it to pay off debt, you're putting yourself at a time disadvantage by waiting until the following year to collect money that belongs to you. All the while, interest continues to grow on your loans and compound interest is forgone on money you could have invested.
If there's a good lesson to be learned from this tax data, it's that Americans could be a lot smarter with their money by staying on top of their W-4s.