Originally published on Forbes.com.
Early filers being disappointed at the size of their refunds or shocked by a balance due seems to be a thing. This story by Madhuri Sathish is one of many.
So I am going to violate Reilly’s Sixth Law of Tax Planning –Don’t do the math in your head – and tell you what I think it causing the reports of diminished refunds. When you used to fill out your W-4, you had the opportunity to fine-tune your withholding, but hardly anybody bothered. For people whose taxable income was overwhelmingly W-2, this would almost guarantee a substantial refund if they itemized.
TCJA knocks a lot of people out of itemizing and even those still itemizing are getting less out of it. It takes a lot more to get over the standard deduction hurdle. Here’s the thing. The new higher standard deduction is reflected in the withholding tables. So some of the boost in 2018 take-home pay cuts into what would normally be a good-sized refund or, horror of horrors, produces a balance due.
It’s Real Simple Math
Some accountants have little patience for the reactions of taxpayers to this perfectly predictable phenomenon . Here is a tweet from Tony Nitti.
I’m all for misdirected anger, but people being upset that their refunds are down, while ignoring the fact that they paid far less in withholding and thus had more income available all year, is too much for even me.
It took me a long time to figure this out, but there are some things that seem fundamentally obvious to accountants and the people who could be accountants but found better things to do with their lives that are surprising to people who are otherwise quite intelligent.
I can remember explaining to leaders in an organization I was involved in that if we spent more money than we took in, it would lead to trouble. And then there was the would-be entrepreneur to whom I explained that he needed to charge more for his product than he spent on producing it.
The mathematical relationships between withholding and take-home pay and withholding and refund or balance due require second-grade math, but there are college graduates who don’t get it. The interesting question is how bad is this going to get. Last week I spoke to Asesh Sarkar, co-founder and CEO of Salary Finance, who thinks it might get pretty bad and I think he should know. Here is a bit about Salary Finance.
About Salary Finance
Initially, I had a little trouble figuring out what Salary Finance was about from its website which indicates its mission:
Our salary-linked employee benefits, supported by financial education, are designed to move people out of debt and into savings. Doing so may improve productivity and loyalty at work, as well as overall wellbeing.
I’m kind of a cynical bastard, so when I look at a website of a company and I can’t figure out how it is they are making money, my bs detector starts registering.
Fortunately, Mr. Sarkar is a lot more straight forward than his company’s website.
What Salary Finance does is arrange bank loans to employees of large employers (500+). The loans are repaid with payroll withholding. In order to be eligible for a loan, an employee must have been on the job at least six months.
If a loan request is more than 10% of annual salary it gets extra scrutiny and there is an absolute cap of 20%. Interest rates vary from about 5% to 10%. (Note – I heard from SF after this was posted and they indicated that rates are actually 5.9% to 19.9%. At the high end, that does not seem to be that much of a benefit.)
The benefit for the employer is that if your employees are stressed out because they are caught in payday loan bondage or paying high-interest rates on credit cards, a more reasonable loan might get them on the right path. Mr. Sarkar indicated that after the loan is paid off there will be an encouragement to shift the loan withholding into savings.
I have to say that I see a potential conflict between Salary Finance’s mission of moving people from debt to saving and its revenue model which is a spread on the loans. There is also the fundamental truth which I learned from my first managing partner, the late Herb Cohan – You will never get out of debt by borrowing.
The Missing Refund Problem
Salary Finance, anticipating the refund problem based on anecdotal reports, commissioned a study on how much people rely on tax refunds.
Most people rely on tax refunds for their financial health, with 40.8% of respondents reporting that they plan to use their tax return to pay off debt and loans, and 16.2% earmarking their tax return to pay off medical debt. Another 32.6% say that they rely on tax returns to stabilize their bank accounts.
Mr. Sarkar framed the problem this way.
While tax refunds might have once been a nice bonus, they now play a critical role in Americans’ financial wellbeing and budgets. If the January shutdown, or a new shutdown, creates a delay in refunds, millions of Americans who depend on these funds to get by could face significant financial consequences. News that this year’s returns could be lower than previous years’ only exacerbates this problem. More than 48 percent of working Americans already have financial worries that lead to sleepless nights, distractions at work, and a reduction in productivity. Instead of relying on high-interest payday loans or credit cards to cover shortfalls, taxpayers worried about budget shortfalls should consider alternative options for affordable loans. Employers in particular can help their employees cope with these setbacks by providing financial wellness options, such as low interest salary-linked loans.
Is Overwithholding A Sucker’s Game?
I remember early in my career, a lot of preaching on the idea that over-withholding was bad. This was back in the day when money actually earned interest. I remember money market accounts earning 12%. If people behaved perfectly rationally, over-withholding makes no sense. But people are not rational. There is a whole subfield of economics called behavioral economics that studies the phenomenon. I call it stupinomics.
What I found was that by disciplining myself to live on my regular take-home pay and automatically saving any other random inputs, I started getting ahead. Included as a random input, was the fifth paycheck you occasionally get when you are paid weekly. With that model over-withholding enhanced my long term security. It was admittedly not rational, but it worked.
Try To Live Within Your Means
I don’t know whether the stories I read about people not being able to come up with four hundred bucks for an emergency are a sign of the times or a pretty universal condition. Think about Dr. Lydgate in Middlemarch or the father in Mill On The Floss . (If you have not read those works by George Eliot, finish this post and start on them. They are free on Kindle). If you are counting on your tax refund for solvency and your income is not on the abject poverty side, take a close look at your spending. It is really boring old fart advice, but sitting here in an RV in Florida at 67, I can tell you it works.
Trackbacks/Pingbacks