Each year, millions of tax filers eagerly await a refund, and 2020 is no exception. Since the IRS began accepting tax returns in late January, taxpayers who got theirs in early are already starting to see their money.
But early data from the IRS reveals that so far, refunds are coming in smaller this year compared to 2019. As of a few days ago, the average refund was $3,125, compared to $3,143 at the same time last year. And while smaller refunds are a good thing in theory, they could be troubling for those Americans who count them on the most.
The impact of lower refunds
Contrary to a common misconception, a tax refund isn't free money. Rather, it's earned income that was never collected up front.
When you receive a paycheck, your net pay (meaning the amount you bring home) accounts for taxes on your wages. Sometimes, you'll have too much tax withheld from your earnings, and when that happens, you're owed money by the IRS when you file a tax return. As such, your refund isn't a gift or windfall -- it's delayed earnings you're finally collecting.
Still, a large number of U.S. households depend on tax refunds to cover major bills, pay off debt, or address expenses they've been putting off, like medical care. For these families, a lower refund than expected could be hugely problematic.
Now so far, the average refund is a mere $18 less than it was last year, which is a fairly minimal difference. But one thing taxpayers should be aware of is that following the Tax Cuts and Jobs Act passed in late 2017, the IRS issued updated withholding tables for employers to follow. Workers who didn't adjust their withholding likely saw an uptick in the money they received in their paychecks, but these same people risk getting a lower refund as a result of having collected more of their earnings up front.
Again, a lower refund shouldn't be a bad thing in theory -- it means you gave the government less of an interest-free loan, and instead received more of your wages as you earned them. But if you're banking on a specific refund amount and it ends up being less, your financial plans could get thrown for a loop.
Don't rely too heavily on a refund
It's difficult to predict what your tax refund will amount to, since there are different factors that go into calculating that number. As such, you're much better off building savings than banking on an IRS payday. If you make an effort to sock away some money, you'll have a means of tackling expenses large and small, and you won't have to sit around waiting for a refund that may not be the number you expect.
In fact, if you're used to getting a sizable refund, it pays to take a look at your withholding and make adjustments so you get more money in your paychecks month to month. If that change results in an extra $200 a month in your pocket, you can put that money into savings and dip in as needed, rather than let the government hang onto that $200 a month.
In 2019, the average tax refund was $2,869 -- just a bit lower than the $2,910 refund the average tax-filer collected in 2018. It's too soon to tell what the average tax refund will look like in 2020, but if you haven't yet submitted your return, prepare for the possibility that you may see a little less money back from the IRS this year.