Last year was the first year we implemented the Tax Cuts and Jobs Act into our tax prep, and a lot of people were surprised to learn that their tax refund would be smaller than usual. However, that doesn’t mean that the new tax legislation is bad for your bottom line.
Remember: a big tax refund isn’t always a good thing. In many cases, it means you gave the government too much of your money in advance—and didn’t get anything to show for it but a tax refund check.
Basically, when you get a refund, the government is giving you money that you didn’t owe in taxes, but paid them anyway (via paycheck withholdings, quarterly estimated taxes, etc.). Unfortunately, the government doesn’t pay you back with interest, which means you could have gotten more money by putting that cash into a savings account, investing it, or paying off debt that would have accrued interest.
Here’s a Washington Post video from 2014 that uses Peeps to explain the concept:
And yes, one of the reasons people like big tax refunds is because getting a big chunk of “extra money” all at once feels more significant than getting a slightly larger paycheck every two weeks. It’s a lot easier to think “I’m going to use my big refund check to pay off debt” than it is to think “I’m going to use the extra dollars in my paycheck to pay off debt.”
But the new tax law is designed to give us bigger paychecks and smaller refunds. Here’s MarketWatch’s summary of how the Tax Cuts and Jobs Act affected taxpayers:
The new withholding levels resulted in lower 2018 refunds for many. Most of these folks actually paid lower taxes for the year, but received lower-than-expected refunds after filing their 2018 returns. For the many who depend on tax refunds for an annual “Spring Bonus,” lower-than-expected refunds felt like tax increases.
You should also be aware that the IRS recently revamped the W-4 (that’s the form in which employees specify how much tax they want withheld from each paycheck) to make it easier to understand how much money you’re loaning the government in advance. However, this new form is also designed to reduce tax overpayment—which means you might get even smaller tax refunds in the future.
On the plus side, all of these tax tweaks might lead to more money in your paycheck. It’s your job to make sure you use that money wisely.
This story was originally published in 2014 and was updated in February 2020 with new information.