A lot of people have slowly but steadily started getting their tax refunds based on the latest IRS schedule. But one question that keeps coming up is why is my refund so small? Or more precisely why is the refund payment so much lower than expected when I filed or compared to past years. Below are some reasons why this could be happening to you.
New Tax Reforms and Laws
One significant reason for lower refunds is that new tax laws and reforms that took effect a few years ago cut several popular deductions (e.g. personal exemption state and local taxes capping at $10,000) for a number of Americans. This and lower tax rates meant people got higher paychecks during the year, but their refund payment was lower at tax time.
Stimulus Payments and Recovery Rebate Adjustments
In the latest tax year (2020-2021) tax refund amounts have been impacted by the several rounds of stimulus payments (adult and dependent) that were essentially refundable tax credits (recovery rebates). Or to state it simply they provided a credit against your future tax return and in some cases if you were over paid then the IRS could have offset your refund (see section below) to cover the difference. This would result in your tax refund being lower than expected.
Unemployment Tax Credits
Due to the pandemic millions of Americans ended up relying on enhanced unemployment benefits. But many didn’t realize that unemployment benefit income is taxable (federal and state in some cases). So like regular income, jobless workers needed to adjust their withholdings and if they didn’t withhold enough from their unemployment pay checks they could see a lower than expected refund when filing their tax return or as the IRS makes adjustments based on 1099G forms that state unemployment agencies submit. The good news though is that the recent ARPA stimulus bill included a $10,200 unemployment income credit, which could result in a bonus refund check in 2021.
Federal Tax Refund Offset
Another major reason why some folks refund is actually less than the amount they were expecting or provided by their e-filing tool is that the federal government has “offset” or deducted monies from your tax refund to cover debts you owe other federal agencies. The Department of Treasury’s Bureau of the Fiscal Service (BFS) manages the Treasury Offset Program (TOP) and may reduce your refund (overpayment) and offset it to pay for the following items (under tax topic 203):
- Past-due child support;
- Federal agency non-tax debts;
- State income tax obligations; or
- Certain unemployment compensation debts owed to a state
Under the law, federal payments such as tax refunds can be collected against by approved agencies (e.g the IRS) before being paid to you. You will get a letter from the IRS explaining this offset to your federal refund and why it differs from what was estimated in your filed return. They will give you an opportunity to dispute this collection, but you will have to prove you had no federal obligations. If you have questions or disputes regarding the offset of your refund for the above items you should contact the Treasury Offset Program (TOP).
Smaller Refund Scenarios
Other reasons for smaller federal refunds can be attributed to various causes related to your income, tax rate and number of withholdings claimed via your W4. Here is a sampling of scenarios based on actual reader comments that could be causing your refund to be much lower than you expected.
Scenario 1 (multiple jobs): Mary is a single person and in the past has always gotten a large refund back. However this year, Turbo Tax showed she was due a $400 tax refund. But Mary made way more last year than ever having worked for two different companies. Mary made $15,000 at one job (tax withholding was ~$1200). At her other job she made $14,800 and had a similar withholding amount. So should she have got a larger refund since she made more money?
Answer: The reason Mary is getting a much smaller refund is that her tax withholding was much lower than it should have been since it was likely calculated for each job based on her salary being the annual amount. That is one employer thinks she earned $15,000 and withheld taxes based on that annualized income. The other place thinks she earned $14,800 and withheld taxes based on that income. But Mary really earned $29,800 for the year and should have had more taxes withheld based on your total income. To fix this going forward she needs to adjust her W4 for the current tax year is she wants to get a larger refund the following year.
Scenario 2 (too few withholdings): I tried several tax software providers and they all come back with a federal refund of only a $95. This is the lowest I have ever got and I made the most money ever this year. I am single, own no property or anything, made around 14,000 last year ($590 federal withholdings). I claimed 2 deductions (withholding) on my paycheck as I have no dependents.
Answer: The answer for your lower refund is your deductions claimed via your W-4. Based on $14,000, your taxable income is around $4,850. Tax on that amount is $495 and with having $590 taking out, you’d get a $95 refund. You must have your deductions higher than 2 if you want more tax taken out so that you can get a higher refund next year.
Scenario 3 (making more money than last year, smaller refund): Last year my wages were around $30,000 (withheld taxes of $2,240) and state income tax was $1,500. When I entered this info into TurboTax get a free refund estimate before filing, both of them showed my federal refund at $47. However two years ago I made much less (around $22,000) and my return was almost $2000. What is going on? I am a single filer with no dependents and didn’t claim or get any other credits.
Answer: The most likely reason for the smaller refund, despite the higher salary is that you are now in a higher tax bracket. And you likely didn’t adjust your withholdings for the applicable tax year. To understand this you need to realize that your tax refund is determined by your total income, marginal tax rate and the amount of federal/state taxes that are withheld. So since your taxable income was higher you fell into a higher tax bracket that resulted in higher taxes. But you would have got more money on a weekly basis (due to your higher salary) as well – which is better than getting a larger refund in my opinion.
At the end of the day getting a smaller refund with a higher income is not actually a bad thing in most cases. It basically means you didn’t give an interest free loan to the IRS (which is what a refund represents). In reality you don’t want a large refund as you should get the money in your pay check when you earn it. Not a year later.