While fall is full of pumpkin-spiced lattes and family feasts, it's also the perfect time of year for the average American taxpayer to start thinking about their taxes. Though tax-planning is really a year-round affair, most taxpayers prefer to put it off as long as possible -- and who can blame them?
According to the Tax Foundation, an average of 144,500 words has been added to the U.S. tax code per year between 1955 and 2015, culminating in more than 10 million words of tax code (and growing). Mind you, this doesn't include long court-case documents that help define some of the tax guidelines. All in all, that's enough words to fill 157 average-length novels, and it results in taxpayers spending 8.9 billion hours complying with federal tax laws each year. I don't know about you, but I don't have that sort of time on my hands.
The average tax refund over the past 10 years is pretty large
Considering how burdensome tax-planning can be, a number of taxpayers simply choose the set-it-and-forget-it path. In other words, most folks choose to set their W-4 (the IRS's tax-withholding form) and don't make any adjustments throughout the course of the year. For many Americans (usually 80% or more), this results in a federal income-tax refund come the following year.
How big of a tax refund depends on a number of factors, including an individual's or couple's income, as well as what credits and deductions are available. But for the typical American, the average tax refund has been sizable over the past 10 years. Here's a quick look at what the average tax refund has amounted to over the past decade, according to data from the Internal Revenue Service and 20somethingfinance.com. Please note that the refund is based on the prior year's calendar return. Thus the 2017 federal tax refund is based on taxpayers' 2016 calendar year tax return.
- 2008: $2,728
- 2009: $3,036
- 2010: $3,003
- 2011: $2,913
- 2012: $2,803
- 2013: $2,651
- 2014: $2,952
- 2015: $2,793
- 2016: $2,857
- 2017: $2,782
It's also worth noting that because of 2017 tax-filing extension data not yet being included by the IRS, the 2017 average refund may still be subject to modest changes in the weeks to come. However, if we average these refunds out on an unweighted basis (i.e, without factoring in the number of returns filed annually), the average federal income-tax refund over the past 10 years works out to $2,851.80. Considering that the median American earns about $30,000 annually, this represents a refund of nearly 10% of their income. That's huge!
According to GoBankingRates, nearly four out of five Americans planned to use their refund in 2017 to either pare down their debt or put money into a savings account.
Nearly 109 million Americans made this error last year
Though GoBankingRates' survey suggests that taxpayers are being reasonably smart with their refund, it doesn't mask the fact that 108,761,000 taxpayers, per IRS data, made a pretty big mistake last year when planning their tax liability.
While receiving a fat refund from the federal government come February, March, or April of the following year might seem like the second coming of the holiday season, getting a big tax refund is almost always a bad move. It signals that you didn't manage your money properly in the previous year.
One of the biggest issues with allowing Uncle Sam to hang on to your income is that it's earning no interest whatsoever. This means that any level of inflation is going to reduce the purchasing power of your refund. When added up over a lifetime, the amount of earning power you lost out of on could be substantial.
More importantly, if you're among those nearly 109 million folks who received a federal tax refund, that's your money that you're allowing the federal government to hang onto. If you have revolving credit card debt, that money would be far more useful right now rather than three, six, or 12 months down the road after you've accrued interest at 19.99% a year on what you owe. Similarly, being able to invest that money now as opposed to next April could have resulted in healthy gains in the stock market. Long story short, there are numerous ways you can put your money to work right now, rather than letting it sit in Uncle Sam's coffers earning no interest for the next couple of months.
Give yourself a raise right now
The solution to this problem is actually simpler than you realize: Adjust your tax-withholding via your W-4. You should be able to adjust your W-4 (often with your company's human resources office) in a matter of minutes, and you can do so as often as needed throughout the year. The federal government has no clue how much it should tax you. It's relying on your input, and this W-4 is the best way to control what comes out of your paycheck.
If you foresee a big refund headed your way in an upcoming tax season and want to boost your take-home pay right now, consider lowering your withholding or even claiming an exemption. The goal should be to get as close to $0 owed and $0 refund as possible. If you've done that, then you've done an effective job in the tax-planning department.