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Exploring the refund riddle

Given its reputation as more opaque than a pile of red tape, the IRS isn’t offering definitive clues as to what’s behind the refund retreat. Even the astute fact-finding outlet Politico has labeled it “a tax mystery” and described a trend in a story from April this year.

“Before the pandemic, about three-quarters of filers typically got refunds. Now about 65% do. The IRS distributed fewer refunds last year — 105 million — than it did in 2010, despite collecting 20 million more returns,” says the article. “Meanwhile, the number of people owing at tax time has been surging. Nearly 40 million people had balances due last year, up by a third from the pre-pandemic years.”

The article throws up a few reasons the number of refunds may be dropping.

One reason could be that there are more tax filers earning income that isn’t subject to the tax-withholding system, like gig economy workers and other independent contractors, and Airbnb owners. If they fail to make quarterly “estimated” tax payments to the IRS, they are charged penalties that eat into their refunds. The same could be the case with those trading stocks and cryptocurrencies and failing to pay taxes on their capital gains.

Politico notes that “the number of filers charged penalties for failing to pay estimated taxes jumped last year to 13 million, a one-third increase compared to the year before the pandemic, IRS statistics show. More than four million of them made less than $75,000.”

Another possible reason, it says, could be the way the Trump administration revamped the withholding system itself, designing it to reduce refunds and making it more confusing.

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Growing your refund once the check arrives

If you pay your taxes on time and correctly, you’re likely to receive a refund and avoid any penalties.

A great use of refund money involves paying off credit card debt. Banks, seizing the opportunity to profit off interest charged to borrowers, have super-boosted APRs with the average going from 12.9% in late 2013 to 22.8% in 2023, according to the Consumer Financial Protection Bureau. That’s the highest level recorded since the Federal Reserve began collecting data in 1994, the CFPB says. The average APR margin (the difference between the average APR and the prime rate) increased 4.3 percentage points from 2013 to 2023

Even if you paid off $100 a month on a $3,000 credit balance, which may seem like a good amount, it would still take you three years and nine months to eliminate it at 22.8% – during which time you would fork over $1,484 in added interest. On the other hand, a refund gives you the opportunity to pay off that whole balance much faster.

It also makes sense to invest that refund, even in the most basic of ways. For example, a low-cost index fund that tracks the S&P 500 would’ve almost doubled your investment over the last five years if you also reinvested your dividends. That means that $3000 invested in 2019 would be nearly $6,000 today (before factoring in inflation).

And if you want to get creative, take some of that money and squirrel it away to work with a super-savvy accountant next year. It might cost you more upfront. The overall average cost of individual tax preparation jumped from $213 in 2021 to $248 in 2023, according to a 2023 study by the National Association of Tax Professionals.

But a CPA or tax pro versus a moonlighting friend will pick up deductions that are easy to miss, from charitable contributions to student loan interest. So like any smart investor, do a cost-benefit analysis. If $500 to hire a top-flight accountant increases your refund by $1,000, you’ve just turned Uncle IRS into the disgruntled one.

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Lou Carlozo Freelance writer

Lou Carlozo is a freelance contributor to Moneywise.

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