Some Americans are getting an unwelcome surprise this tax season, with refunds down about 9 percent so far this year. Getting less money back, not to mention having to write a check to the IRS, can sting, especially if a taxpayer was expecting the usual windfall.
Even tax experts are getting slammed by the tax changes. “One of my accountants came to me just before, she did her taxes this year and owes $7,000. This is definitely real,” said Jonathan Medows, manager partner at Medows CPA. Asked what he told his accountant, he said, “There’s nothing they can do. They owe money.”
Such anecdotes are sparking debate over whether the new tax law, officially known as the Tax Cuts and Jobs Act and which took effect last year, is delivering the benefits that President Donald Trump and other Republican lawmakers promised.
“The tax code picks winners and losers, and there are going to be winners and losers as people file their tax returns,” Dan Geltrude, founder of accounting firm Geltrude and Co., told CBS News.
Smaller refund this year? Wrong yardstick
First, it’s important to note that while taxpayers often fixate on the size of their refunds, that’s not an accurate yardstick of whether the new tax regulations are helping or hurting you, experts say.
“If you are assessing whether you came out ahead or not solely of the size of your refund, that is the wrong way to go about this,” said Nick Holeman, a certified financial planner at investment company Betterment. “The size of the refund is only part of the picture.”
A puny refund or even an unexpected bill don’t necessarily indicate a taxpayer has been hard-hit by the new tax laws. Holeman said he himself aims to come out even at tax time, neither owing nor being owed money by the IRS.
“i personally think [it is] a great thing” that refunds are lower this year, he said. “You don’t want to give an interest-free loan to the government unless you absolutely have to.”
A better metric
The key to figuring out whether you’re coming out ahead under the new tax bill isn’t the size of your refund, but what’s known as your effective tax rate, Holeman said.
The effective tax rate is a percentage that explains how much of your income was paid in taxes. It’s not the same as your marginal tax rate, which represents the taxes paid on each dollar earned above a particular tax bracket. For instance, the IRS taxes the lowest amount of income at the lowest tax rate, and then increases rates as a person’s income rises.
That means a person’s highest marginal rate could be 37 percent — the highest individual rate under the new tax law — but their effective rate is usually much lower.
“If that effective tax rate went down, you are better off — even if your refund went down,” Holeman said.
How to calculate your effective tax rate
First, you’ll need to calculate your effective tax rate for 2017. That can be determined by finding your total income on line 22 of your IRS Form 1040 from last year. Then look on on page 2, line 63, which provides your total tax. Divide your total tax amount by total income and you’ll determine your effective tax rate.
The Form 1040 for this year’s tax season has a slightly different format. Total income will be listed on line 6, and total tax is on line 15. Do the same calculation to determine your effective tax rate under the new law.
Some taxpayers may have a lower effective rate, but are receiving smaller refunds because they either didn’t adjust their withholding or their employers already paid more into their paychecks, tax experts said.
“I have one client, their effective tax rate went down by 9 percent, but their refund went down,” Medows said. “My classic client is making income of about $120,000, and their tax rate came down but the withholding wasn’t the same. So the refund is smaller.”