February 28, 2014
by Kerry & David Pickett, EA
Why is (insert appropriate name here)’s refund so much larger than mine? As tax preparers we often hear this, many times with a hint of a “you must have done something wrong?” inference. So this article will attempt to demystify how refunds are determined. There are many factors that go into determining a tax refund. We will focus on the Federal refund because the same rules apply to all states. State refunds are determined by the state of residence.
If you are paid via a W2 by your place of employment, you will have an amount taken out for federal withholding tax. This will be in part determined by the amount of withholding you requested on a W4 form that you filled out with your employer. It is very important that you check this from time to time as it will be affected by new state rules, and/or an increase or decrease in your yearly income. Lower withholding or lowering the amount of deduction from your paycheck will mean a lower refund or you may possibly owe. If you have been following closely, this means your refund is getting back your OWN MONEY. Many times we hear people proclaim proudly of their large refunds. Some who hear oooooh and ahhhh and no doubt wonder why theirs is not that high as well. I repeat YOU ARE GETTING BACK YOUR OWN MONEY. We wonder why they have allowed Uncle Sam to use their money all year with no interest! As tax professionals, we are more proud when our clients neither owe nor get a refund for we have done a good job of advising them on withholding enough to maximize their paychecks and not pay too much withholding.
If you were paid via a 1099 for your work, you are considered a sub-contractor (or self-employed) and NO taxes will have been taken out. In addition to other withholding like self-employment tax, social security, Medicare, there have been NO federal or state taxes taken out so these will be owed at tax time. There may be times when you will get both a W2 for regular employment and a 1099 for a bonus for instance. In this case expect your refund to be lower or you may actually owe taxes. A can be a nasty surprise for some.
Periodically check your pay stub throughout the year and see if you are on track. A good rule of thumb is to make sure that at least 15% of your gross salary is being withheld for Federal taxes and at least 5% for state taxes.