Tax Policy – Your Tax Refund Doesn’t Tell You How Much You Paid in Taxes
Tax filing season brings up many questions for taxpayers, such as, “How big will my tax refund be?” or, “Will I have a balance due when I file taxes this year?” However, one of the biggest questions taxpayers should ask is, “How much did I pay in taxes?” If taxpayers focus solely on the size of their tax refund, they miss a key part of the equation that’s often overlooked: the impact tax withholding has on tax filing.
Most employers are required to withhold income taxes each time they pay their employees. The amount that employers take out of each paycheck and send to the Internal Revenue Service (IRS) is based on withholding tables, which instruct employers on how much tax to withhold from an employee’s paycheck. Employees contribute to this process by filling out the form W-4, where they account for their filing status, dependents, tax deductions, and other details that can affect their tax burden. The amount of taxes withheld varies based on paycheck frequency, the W-4 form, and salary.
This leads to three possible outcomes when filing taxes:
- Accurate withholding—the amount withheld from the employee’s paychecks matches the amount they owe in taxes, so they do not receive a refund or owe taxes when they file.
- Underwithholding—the amount withheld from the employee’s paychecks was not enough to pay the amount they owe in taxes, so they have a balance due when they file and could potentially face a penalty for underpayment depending on the size of the underpayment.
- Overwithholding—the amount withheld from the employee’s paychecks exceeds the amount they owe in taxes, so they receive a refund (without interest) when they file.
The U.S. Treasury Department estimates that nearly three-fourths of taxpayers have too much taken out of their paychecks, resulting in overwithholding and tax refunds. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s.
Regardless of whether an individual overwithholds or underwithholds, receiving a refund or owing the IRS come tax time is not the best way to evaluate your income tax burden. Instead, taxpayers can look at their Form 1040 to see how much total income tax was paid and compare that amount to how much they earned in the year to determine their effective income tax rate. If an individual wants a more accurate withholding, they can use the IRS Tax Withholding Estimator tool and update their form W-4 with their employer.
Source: Tax Policy – Your Tax Refund Doesn’t Tell You How Much You Paid in Taxes