Why Are Tax Returns So Low This Year?

This year, many taxpayers are facing an unpleasant surprise as their tax refunds are significantly lower than expected. This trend has caused widespread concern and confusion among individuals trying to understand the reasons behind these reduced refunds. Understanding why refunds have decreased is essential for financial planning and managing personal budgets effectively. Let’s examine the key factors contributing to this shift.

Changes in Withholding Calculations

Recent updates in withholding calculations have had a major impact on reduced tax refunds. The IRS revised the withholding tables to align with current tax brackets and rates under the Tax Cuts and Jobs Act (TCJA). These adjustments aim to ensure the correct amount is withheld from paychecks throughout the year, reducing over-withholding and, consequently, smaller refunds.

Employers now use the updated Form W-4, which requires employees to provide detailed financial information, such as additional income, deductions, and credits. While designed to yield more accurate withholding amounts, many individuals may have misunderstood or incorrectly completed the form, leading to unexpected outcomes.

The IRS also allows mid-year adjustments to withholding, accommodating changes like a new job or significant life events. Taxpayers need to actively monitor and adjust their withholding to avoid surprises during tax season.

Reduced Refundable Credits

Another key factor is the reduction in refundable credits. Refundable credits, which can reduce tax liability below zero and generate a refund, have undergone changes. The Child Tax Credit (CTC) and Earned Income Tax Credit (EITC) are prime examples.

The CTC, which saw a temporary expansion under the American Rescue Plan Act (ARPA) in 2021, has reverted to its pre-expansion structure. Families now receive up to $2,000 per child, down from the previous $3,600 for children under six and $3,000 for older children. The rollback of the full refundability feature, which allowed families to receive the credit even without tax liability, has hit low-income households particularly hard.

Similarly, temporary enhancements to the EITC, especially for childless workers and younger taxpayers, have not been extended. With eligibility criteria and maximum credit amounts returning to previous levels, those who benefited from the expanded provisions now face reduced refunds.

Itemized Deduction Limitations

Changes in itemized deduction rules have affected taxpayers’ ability to lower taxable income. Historically, itemized deductions included expenses like mortgage interest, state and local taxes (SALT), and medical costs. However, recent policy changes have imposed stricter limits.

The $10,000 cap on SALT deductions remains in place, significantly impacting taxpayers in high-tax states where state and local taxes often exceed this limit. Additionally, the threshold for deducting unreimbursed medical expenses has increased to 10% of adjusted gross income (AGI) for 2024, up from 7.5%, making it harder to qualify for this deduction.

The mortgage interest deduction also remains limited to interest paid on mortgages up to $750,000. Taxpayers with larger mortgages cannot deduct interest on the excess, impacting those with high-value homes. Combined with the increased standard deduction, these restrictions have led many taxpayers to opt for the standard deduction, as it often offers a greater benefit.

Filing Status Differences

Filing status plays a critical role in determining taxable income and can significantly affect refunds or liabilities. Each filing status—Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Widow(er)—has its own tax brackets, standard deductions, and eligibility for credits.

For example, Head of Household filers benefit from a higher standard deduction and more favorable tax rates compared to Single filers, potentially resulting in a larger refund. Conversely, Married Filing Separately status often comes with restrictions, such as ineligibility for the Earned Income Tax Credit and reduced IRA contribution limits. This status may also lead to higher tax rates and fewer deductions, diminishing refunds. Married Filing Jointly typically offers broader tax benefits, but it may not always be the best option for couples with complex financial situations or disparate incomes.

Unexpected Taxable Income

Unexpected taxable income has also contributed to lower refunds, catching many taxpayers off guard. The rise of gig economy jobs, freelance work, and side hustles has introduced additional income streams that often lack tax withholding, leading to higher year-end liabilities. Platforms like Uber, Etsy, and freelance marketplaces typically do not withhold taxes, leaving individuals with surprise tax bills.

Investment income, including interest, dividends, and capital gains, also impacts taxable income. Market fluctuations can create variability in these gains, complicating tax planning. Additionally, the sale of assets like real estate or business interests can generate taxable capital gains, further increasing tax liability.

To avoid surprises, taxpayers must track all income sources throughout the year. Estimated tax payments or adjustments to withholding on other income can help manage liabilities. Keeping detailed records and consulting tax professionals can ensure a more accurate understanding of potential obligations and deductions, leading to better financial outcomes.