If you received a tax refund that was smaller than you expected this year, chances are it’s not a random mistake. Rather, some paperwork you filled out at your job is likely to blame, and with a little digging you can figure out exactly what happened.
Currently, the average 2020 tax refund is about equal to last year's — roughly $2,800 — but every year a sizable number of taxpayers say they are surprised by the amount of their tax refund or tax bill.
Experts say one of the most likely culprits of a pint-sized refund is that you aren’t withholding enough from your paychecks for Uncle Sam. But there’s a way to avoid that unwelcome surprise: Workers have the chance to tell the government how much to withhold from their paychecks for state, federal and local taxes throughout the year using a Form W-4.
The IRS released a new version of the form at the end of 2019. A year later, the American Institute of CPAs (AICPA) found only one in four workers had updated their withholding since the new form was introduced.
“If you have the same withholding form that was in effect before tax reform, the older withholding form you filled out wouldn't have accounted for the new aspects of the tax law,” says Neal Stern, CPA, and a member of the American Institute of CPAs Financial Literacy Commission.
While it may be easy to put off updating your form or seem like just a minor detail, Stern says it can end up costing you thousands of dollars and even a penalty come tax bill time if you don’t update your withholding information as soon as possible.
Why is my refund so low?
For example, if you filled out your Form W-4 when you were employed and your spouse was unemployed — but then your spouse got a new job — you’ll be hit with a smaller refund (or a larger tax bill) at the end of the year in order to account for your increased household income.
And if you have multiple streams of income, which could include Social Security income, income from a second job or even unemployment income, that additional money could also be taxable and need to be factored into withholding.
“I always say that if someone gets a little refund, they got their withholding right,” Todd Simmens, BDO’s National Managing Partner of Tax Risk Management, says.
So when do you need to update your Form W-4? When you start a new job, it will typically be included as part of your paperwork. But there are other events that should trigger a reminder to change your withholding amount. “If you've got a large refund or owed a lot of money when you are doing your taxes now, that's probably the number one clue that people would see [to update their W-4],” Stern says.
How much taxes should I withhold from my paycheck?
If you're welcoming a new member of your family, such as a child or an additional dependent, that’s another clue, according to Stern. Divorce, marriage, your spouse getting a new job or losing their current job — which happened to many people in 2020, when the unemployment rate hit a record high of 14.7% last April — are all times when you should update your withholding.
An increase in your salary may bring you into a new tax bracket, and you’ll want to take another look at your withholding preferences then, too, Simmens says. He likens it to the adage, “when the clocks change, change your smoke detectors. When your salary changes, it’s time to take another look at withholding.”
The best way to know how much you should be withholding? Go to the IRS website and use the withholding calculator to account for all your sources of income, and then use that amount to fill out a new Form W-4.
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Correction: a previous version of this story misstated the number of workers who had updated their withholding since the IRS released a new Form W-4 at the end of 2019.