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The Hidden Reason Tax Refunds Are Smaller

By Dan Caplinger – Mar 1, 2019 at 9:35AM

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Look more closely at the numbers.

Taxpayers are getting their first crack at preparing their returns under the new tax laws, and many people aren't happy with what they're seeing. Already, early readings from the federal government on how tax season is going this year have some alarming implications, with smaller refunds casting doubt on the tax-saving promises that lawmakers made when they enacted reform legislation in late 2017.

As gloomy as the commentary surrounding tax refunds this year has been, there's cause to believe that things might get better. In the end, it might well be that a very simple yet hidden reason has kept refunds down during the early part of tax season -- and why things could look a lot better in the final accounting.

1040 return with magnifying glass on top of it.

Image source: Getty Images.

Why people are panicking about tax refunds

When you look at the data from the Internal Revenue Service as of Feb. 15, it's easy to paint an ugly picture of how tax season is going from a refund perspective. Consider:

  • The average refund amount is down by more than $525 from this time last year, to $2,640.
  • The number of refunds issued is down by more than 26% from year-ago levels.
  • Put those numbers together, and the total amount paid in refunds has plunged almost 39% -- or nearly $40 billion -- to just under $62 billion.

Even before tax season started, there were warning signs that this year's refunds could shrink compared to those from the 2017 tax year. Changes in the withholding tables that the IRS uses to tell employers how much in federal tax withholding to take out of employee paychecks accounted for the changes in tax rates, but they couldn't adjust for individual issues like itemized deductions or changes in eligibility for tax credits. Many believe that paychecks rose during 2018 because less money was withheld from the typical paycheck, and that had the consequence of reducing the size of refunds early this year.

Bring on the tax credits

One encouraging sign for supporters of tax refunds is the fact that the average has jumped substantially in just the most recent week. When the IRS issued its previous data release, it indicated average refunds of less than $1,950. The average has surged almost $700 in a single week.

That's a typical phenomenon in recent tax years because of a change in the law. Those who claim popular tax breaks like the earned income tax credit or the additional child tax credit can file their returns whenever they want, but the government won't issue refunds until mid- to late February. That's because those credits are frequently abused in fraudulent returns, and putting safeguards on refunds linked to those tax breaks can help reduce the incidence of abuse -- albeit at the cost of inconvenience to taxpayers legitimately claiming them. Indeed, this time last year, the average refund jumped by more than $1,000 during that same week. That suggests a different problem might be having a negative impact.

Could the answer be as simple as this?

Yet there might be a much simpler answer: New tax forms are making it more challenging for taxpayers to get their returns done. It's true that the format of the new 1040 form was designed to make it simpler than in past years, and longtime filers of the 1040 can quickly see the extent of the changes. But for taxpayers who are intimidated even by the old Form 1040-EZ, change of any kind is hard to get through. That might well be enough of an impediment that it's causing even those who'd be entitled to extremely large refunds to hold off before filing.

That's showing up in some of the numbers. Tax returns received are down 7% from year-ago levels, and processing of returns is down 10%. In particular, the number of professionally prepared returns is down sharply, and many of those who need the most help with their returns have large refunds due to them.

In addition, changes to key tax provisions are leaving many taxpayers scrambling to understand what's motivating such big disparities between the 2017 and 2018 tax years. In some cases, that confusion will legitimately be because the size of their refund has gone down. But in others, it could simply be a matter of working through numbers to discover that offsetting provisions might well leave your refund unchanged or even make it grow from year-ago levels.

Wait for the final tally

It'll be interesting to see how the numbers compare between this tax season and previous ones, but in the end, this tax year will likely prove not to be comparable to other years. With so many changes and other things for taxpayers to worry about, expecting past filing patterns to remain the same isn't realistic -- and that means you'll have to wait until the final numbers are in before you can draw any solid conclusions about the impact of tax reform on the typical taxpayer.

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