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Reasons for tax refund glut

By Kay Bell ·
Thursday, April 28, 2011
Posted: 1 pm ET

The average tax refund last year was $3,003.

Filing data complied by the Internal Revenue Service through April 8 show that refunds issued so far in 2011 are close to that amount. For returns processed by early April, the average refund was $2,895. Taxpayers who had refunds directly deposited to a bank account got a bit more, $3,100 on average.

Large tax refunds have been the trend for more than a decade. A report by The Wall Street Journal found that in 1999 the average tax refund was $1,698, and that the growth in refunds has been across all income levels.

The penchant to use the IRS as a savings account goes against traditional tax advice. Most tax experts, including me here on Bankrate, recommend you adjust your withholding so that you, not Uncle Sam, have use of your money throughout the year.

Obviously, since most people get refunds each tax year, most people are ignoring us.

The next logical question is: Why are folks disregarding our sound tax advice?

One reason is that many people simply aren't good money managers. A lot of these fiscal types are my relatives. They get extra money, they spend it as quickly as they can. Using payroll tax overwithholding as a forced savings account is the only way they can be sure they'll have a sizable chunk of cash to buy a large item or take an expensive trip.

I get that. And given how minuscule savings interest rates have been for the last few years, I have no grounds to scold you for wasting extra earnings.

Still, most people who are getting these annual big refund checks are adults. They should be able to manage their money, and yes, I am talking about -- and to if they're reading -- my aforementioned relatives.

So act like a grown-up when it comes to your money and your taxes. Change your withholding amount so that your money comes back to you each paycheck.

If you don't trust yourself not to spend it, set up direct deposit of the extra pay into a savings account. That way you won't get your hands on the money immediately, but neither will you have to wait until tax filing season to have access to your cash.

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May 02, 2011 at 11:30 am

Great points from all y'all! Thanks.

The underwithholding issue and possible penalties is a tough one, especially when you have fluctuating income; it's hard to predict what you'll earn, much less what you'll owe Uncle Sam. I've used the annualized estimated tax payment system to try to get to a closer through-the-year payment level, but it's complicated and time consuming, even with tax software. So I totally understand overpaying and getting a refund to avoid this hassle.

And thanks for reminding me about state taxes. I've spent a good portion of my life in no-income-tax states (Texas and Florida) so I've happily put this tax obligation out of mind!

May 02, 2011 at 6:59 am

The other side to your query is the penalties for under-withholding. It takes too much effort to adjust and guess what the tax withholding should be during the year, so it is simply safer to over-withhold than to take the risk of penalties. If the Tax Calculation on the 1040 included a determination of what the proper withholding would have been for that year's tax bill (taking into account the deductions etc.) then it might be more feasible to withhold properly.

April 29, 2011 at 9:35 am

The one time I tried to lower my w/holding I ended up OWING $1800. I think it is just too difficult to accuarately calculate it, so most people much rather get it back than have to write out a check! It made me sick to spend the whole year looking at that money coming out of my paycheck and THEN to have to write a check out, UGGH!

I don't go way above and beyond, but I am happy to get an ok return...actually got mine today!!

April 28, 2011 at 7:01 pm

The reason is obvious: Interest rates on savings accounts are almost zero nowadays, so there's no incentive to deposit your money in a bank rather than the IRS.

Debra James
April 28, 2011 at 3:06 pm

Another reason why people are getting larger Federal tax refunds is because they are trying to deduct enough to insure their State income taxes are covered. I live in Californa, and there is a separate withholding form to fill out, DE4, but many people may not know about it, because their employer only gives them the Federal withholding form, W4. On the State form, it clearly states that if you rely solely on using the Federal withholding form, your California income tax may underwithheld. So, people may be overpaying on Federal income tax just to avoid the risk of underpaying their State income tax.