Here we find ourselves in February with Tax Refunds (or Bills) due right around the corner. That refunds are smaller this year is a sentiment shared by a lot of people. This is somewhat true because of the child tax credits and no stimulus payments, but that explanation is far too broad to address intricacies of every situation. The first thing to consider is that a refund is just that, it is what you are owed by the government. You loaned the government money throughout the year and they gave you back what they didn’t’ spend.
The first change is the child dependent and stimulus credits are lower than last year. The pandemic and stimulus money was meant to help offset the cost of having dependents. The advance child tax credit is gone altogether. However, these changes aren’t a departure from the last 10 years as much as the last 2 years in dealing with Covid.
To help debunk a common misconception that the public is paying all of the federal taxes while the very rich avoid tax bills altogether, here are a few statistics that might surprise you. Salaries under $200,000 account for less than 8% of the total tax revenue for the US. The average household income in America is less than $70,000. That means that most people are using more government resources than they are paying for and ultimately paying $0 in federal income tax. The top 1% of all income earners in the country are paying 50% of the total tax Revenue for the US.
Top 1% of earners do have tax strategies that save them a lot of money, however, it’s important to remember that they are paying quite a bit of money to use these aggressive tax strategies. If they are paying 50% of their income in taxes, an expensive tax strategy makes a lot more sense than if you are paying 20% of your income in taxes.
This year, some of our clients are talking about their kids or employees owing taxes more so than usual. If you are self-employed, you already expect to owe taxes and your strategy is typically to get ahead of this payment, or at least be prepared for it. Most employees however, are “banking” on a refund (pun intended). There were some major tax law changes that may be the reason behind this. The new W-4 was introduced in 2020 and intended to be simpler than a W-2 (to read more about the W-4, check out the IRS FAQ page dedicated to this). The intention of a W-4 was to withhold more accurately to get the government and workers closer to breaking even at tax time. Whereas with a W-2, people almost always get a refund because they were overpaying for taxes throughout the year.
The reality is that most people are spenders, not savers, and are more comfortable having more money withheld so they will definitely get money back at tax time, rather than having a tax bill. Refunds affect automotive customers as well, because people with a big bump from a tax refund are more likely to come get bigger fixes on their cars.
Surprisingly, the biggest refund hiccups this year seem to be married couples who both make decent wages and then file jointly. Between that and changing jobs in the middle of the year, these situations throw a wrench on withholdings. If you change jobs, the second job doesn’t know what you made in the earlier part of the year and can often send employees into a higher tax bracket than they expected. Having married couples’ tax forms with a tax deficit at the end of the year generally means someone didn’t withhold enough.
What do you do in a situation where someone didn’t withhold enough? An employer can’t go in and fix how an employee filled out their W-4’s. The Employer is legally obligated to input whatever information the employee put on their W-4 and withhold accordingly on it. It usually doesn’t have anything to do with the business owner and they don’t have to take responsibility, but they can help! First and foremost, make sure there wasn’t a big hiccup or some large irregularity. It might not have been the employee’s financial situation that changed, but their spouse’s. The easiest way to help employees is to talk about how they want to fix it and then increase withholding in a uniform and easy way throughout the year. For example, if an employee is short $5000 from last year, help them create a target. Do they want to plan to cover this debt right away? Do they want to break even next year? Or do they want to receive money back in their next tax return? Once an employer figures out what kind of goal their employee wants to create, you can help them adjust their withholding to meet it.
It’s very simple to withhold a certain amount. Just take the amount they want to withhold and divide it by the number of paychecks. If you’re adding bonuses periodically throughout the year, you might notice that money is coming out of their weekly paycheck but not the bonuses so double check software (QuickBooks is very user friendly on this front) and make sure money comes out like it should. If you have software like ADP, it’s usually as simple as sending an email to a representative.
Helping employees out this way is a great way diffuse what can be a very stressful situation. Hopefully this will help them out from a tax, cashflow, and personal financial standpoint. If employees are having a tough time understanding these concepts, send them to the podcast page and have them listen to minute 9:41 of Episode 54 of Business by the Numbers (https://paarmelis.com/business-by-the-numbers/) . Educating employees is a great way to build trust and avoid tax problems going forward.
