Each year, millions of Americans eagerly await a tax refund upon submitting their returns to the IRS. And while it's easy to argue that tax refunds are not, in fact, a good thing, since they effectively mean you gave the government a tax-free loan during the year, many people appreciate getting to collect that lump sum payment. But in 2019, many tax filers were disappointed with their lower refunds, or absent refunds. And in 2020, many are likely to experience a repeat letdown.
The reason? Americans aren't taking steps to update their tax withholding, and it's changing their outcomes when they file their returns.
How tax withholding works
The U.S. has a pay-as-you-go tax system, which explains why taxes are withheld from your paycheck week after week. The amount of tax that gets withheld, however, is based on the number of allowances you claim on your W-4. The more you claim, the more money you get directly.
Here's the problem: Following the 2018 tax overhaul, which lowered virtually all individual tax brackets so workers could collect more of their money up front, the IRS issued new withholding tables that dictate how much tax employers must hold back. Paychecks largely went up as a result of that overhaul -- but perhaps too much, because since that change, workers have been collecting lower tax refunds, or, worse yet, owing taxes.
Anyone who owed a large chunk of tax in 2018 would've been wise to adjust his or her withholding after the fact to avoid a repeat underpayment. The problem? Many Americans didn't. In fact, tax prep service Jackson Hewitt reports that following the 2018 tax year, 55% of filers did not make changes to their withholding. And 18% of filers don't know if they updated their withholding in 2019.
That's a problem, and here's why: Not only do many Americans bank heavily on tax refunds, but most don't have a healthy level of savings in the bank. Those who underpay their taxes and owe money therefore risk incurring penalties as a result of not having the means to pay the IRS their tax debt when their returns are due.
Make the right changes in 2020
If you failed to adjust your withholding in 2019, it pays to consider doing so in 2020, and the sooner you do, the sooner those changes will take effect. As Mark Steber, Chief Tax Officer at Jackson Hewitt, explains, "When it comes to tax refund amounts, withholdings are the single most important item to keep up-to-date to avoid refund surprises or disappointments. The IRS recently released the final 2020 Form W-4 and withholding tables, so whether taxpayers updated their withholdings in 2019 or not, everyone should be sure to review their current W-4 on file with their employer and, if needed, provide their employer with an updated W-4 in 2020."
Taking a bit of time to check your withholding could save you a world of hassle during the 2020 tax season, so it's a step worth taking. And as for that refund -- well, your best bet is really to stop relying on it, and instead save more judiciously during the year to build cash reserves of your own. Remember, refunds can be delayed, or come in lower than expected, so if you'd rather avoid unpleasant financial surprises, you're better off not counting on one.