Column: Your Fat Tax Refund is Actually Just Bad Math
By Mark Muenster
The tax system in the United States is kind of a cruel joke on poor people.
Receiving a large tax refund at the end of the year is not good and it shouldn’t be normalized. Did you know it’s actually a product of a miscalculation by the federal government? It’s one of many ways the U.S. tax system enables corporations to exploit the working class, especially contractors and those who are self-employed.
This miscalculation is exploited by businesses, like retail stores and car dealerships. Every year during “tax season,” they encourage consumers to use their tax refund to make large, often unnecessary purchases. They promote the idea that a tax refund is essential, “extra” money that should be spent ASAP and make a killing by doing this – every single year.
A large majority of the American tax base is paid via W2s from their employer. The FICA tax, or the Federal Insurance Contributions Act, funds Social Security and Medicare programs in the U.S. It’s 15.3% of your annual earnings. When working for an employer that pays with a W2, the employer covers half, or 7.65%, and the employee pays the other half.
In addition to FICA withholdings, employees also have federal tax withholdings taken from each paycheck. These are prepayments of potential federal tax owed by an individual based on their total earnings for the year. The federal tax is calculated by the federal government and is based on the person’s income and the tax bracket.
An employee pays this amount through tax withholdings on each paycheck rather than making one lump sum payment at the end of the year. Preparing your tax return is all about reconciling the amount of withholdings from your paychecks with the amount of federal income tax calculated by the federal government.
If you had more withholdings than federal tax, the excess is your refund. Meaning, your fat refund is actually a miscalculation by the federal government.
Tax credits increase a person’s refund, with the Child Tax Credit being the most common. Every American’s tax scenario is different, and refunds are not comparable at face value.
What is baffling is that all W2s get reported to the Internal Revenue Service. The IRS has all the information we scramble to gather and decipher, at their fingertips, in its transcript database. With this information already in the IRS’s hands, and with the technology available these days, it’s obvious who the bud of the joke is. There could easily be a more streamlined method for tax filing, so why do they continue to make us suffer? Corporate lobbying.
The status quo is maintained by the corporate lobbying by large tax preparation companies that make bank off of the uncertainty of the filing process.
If you’re self-employed, you are faced with preparing a tax return that you may not feel qualified or educated enough to complete. Without an employer, you face the full 15.3% of FICA taxes. Since a self-employed individual does not get a paycheck, this amount is calculated and collected when they file their annual tax return. This tax is called the self-employment tax, and it can catch new entrepreneurs by surprise if they are not prepared.
Both wage employees and self-employed individuals are faced with the uncertainty of self-filing a tax return themselves and encountering a plethora of up-selling tactics by online tax preparation services. The average taxpayer often gets duped into services they don’t need. The alternative is to pay a tax professional to prepare the return for them.
Employers paying workers as contractors rather than staffed employees is also a huge problem, putting those workers in a bad situation when it is tax time again.
Then there are the taxpayers who fail to file their tax return. The IRS often takes years to send inquiring letters or request unfiled returns. One year of an unfiled return often leads to a snowball effect, with many more years of putting it off, which can lead to unclaimed refunds that become property of the federal government. In the scenario that person owes taxes, the penalties and interest can get out of hand with enough time.
As a tax professional, I'm sure you can tell I've spent the last year unpacking the inequities of the U.S. tax system. Hit me up if you ever need any help.