Last year my wife got a large tax refund, this year she owes taxes on a lower salary!! What gives? Wasn’t there a “tax cut” effective in 2018? Yes, there was, mainly in the form of almost doubling the standard deduction, though people who are used to itemizing and were able to deduct state taxes, found that the state tax deduction was limited. But that’s not the reason most people got smaller federal tax refunds or ended up owing instead of getting a refund. Folks, what does a large tax refund mean? No, not a 4K TV at Walmart. It means you have lent the Federal government money through withholding all year. The larger the refund, the bigger the no interest loan you have involuntarily made! If I asked you, “would you rather have your own income during the year or lend it to the federal government at no interest for the year?” I hope you would choose to keep your money. “But that refund is like a savings account” you say. Well, these days most savings accounts pay about .25% interest, so lending to the government at no interest doesn’t entail much of a loss. But is that the point?
Normally, the federal government moves with all the alacrity of a glacier, but in 2018 it struck at the speed of a rattlesnake strike in changing the withholding schedule. Employers starting withholding less immediately, and it suddenly felt like a tax cut….until refund time. Uh oh, many people suddenly realized there’s a direct relationship between getting a bigger paycheck and a smaller refund, unless you got a raise. I advise all of them to study their paystub and see how much is taken out for what, especially social security. I was “self employed” (meaning I had hundreds of employers, I just called them clients) most of my working life, so understanding how much I was being taxed was never a problem. I always did my own taxes. Early on, I discovered that the vaunted tax deductions applied only to income taxes, not social security taxes, which were called self employment tax. Without deductions, my self employment taxes were always more than my income tax. You’re shocked? You’ve looked at your paystub and your F.IC.A. and Medicare taxes are a lot less than income tax withholding? Guess what, your employers pay half of those taxes.
While you’re at it, examining your paystub that is, there’s another little item that might open your eyes. That’s what is deducted for health insurance, if any. You think that’s a lot? Look at your W-2 at the end of the year to see what your employers pay for your health insurance. It’s usually way more than what you pay. Upsides and downsides usually go together. Big tax refund, less of your money to use during the year; self employment freedom to make more, but no employer to pay half your FICA or your health insurance. I believe they are called trade offs.