Money

Tax refunds are down 8.4 percent so far this year—here's how experts say you should prepare

Man uses laptop to file his income taxes.
Kirsty L | Twenty20

You may be getting less money than you expect in your tax refund this year. Or worse, you may be on the hook to pay.

Refunds dropped 8.4 percent during the first week of tax filing season, the Internal Revenue Service reports. The average refund this year so far has been $1,865, compared with $2,035 during the same period a year ago.

The drop could be an early indicator of how the tax changes introduced in the Tax Cuts and Jobs Act are affecting Americans. "If I were to estimate, two-thirds will pay more than they thought and one-third will get more than they thought," one New York City tax preparer told NBC News.

In recent years, it's been fairly easy to estimate what your tax return would be, especially if you didn't change jobs or go through a significant life event. But the Tax Cuts and Jobs Act, passed in December 2017, enacted a number of broad changes: It introduced new tax brackets, included an expanded child care credit and changed the way itemized deductions are factored in, for example.

These shifts, which are in effect for the first time for the full 2018 tax year, have created a lot of uncertainty. About 28 percent of Americans don't understand exactly what changed and almost half have no idea how the changes affect their tax bracket.

Given all that, here's what experts say you should do now.

Don't bank on a refund

Because of the general confusion and the sluggish refund rate, tax experts say you shouldn't assume you're getting, or rely on, a big refund this year.

That's easier said than done, though, especially because many Americans earmark their refunds for big purchases. For some, it goes toward necessary purchases like a car, for others, it's a vacation, but for some, it's crucial medical expenses they've been putting off.

Still, it's the reality: "Taxpayers should definitely adjust their expectations when it comes to their tax refunds this filing season," says Logan Allec, a CPA and owner of the personal finance blog Money Done Right.

Taxpayers should definitely adjust their expectations when it comes to their tax refunds this filing season.
Logan Allec
CPA

Unless you've actually run the numbers beforehand — this is, you've taken the step to compare how much you expect your total tax liability for the year to be versus how much you've paid in through withholding and other payments — Allec says, "it's almost a fool's errand to 'expect' to receive some certain refund amount, or to even receive a refund at all."

In fact, he says, "when it comes to refunds, it's not really a good idea to count on them as part of your budget, especially when it comes to large purchases or trips."

Hold off on big purchases

You don't want to be in a situation where you start dreaming about a trip you can take with your expected tax return — or even worse, book airfare, hotels and sightseeing tours in advance — only to find out that money isn't on its way. "Don't count your chickens before they hatch," Allec says.

Once your tax returns are completed and you know the exact results, then you can decide if you want to spend on those "extra luxuries" in 2019, says New York-based CPA Anil Melwani. "This will feel much better than struggling to pay off something because more of your money had to go to the tax authorities."

One of the worst financial situations to be in, Melwani says, is to be behind on your income taxes: "We work with people in these types of situations every day. They can be quite unpleasant to encounter and to explain to the rest of your family."

File early

If you are concerned about your tax situation, the best thing to do is to file early, experts tell CNBC Make it.

"Taxpayers should file their returns or estimate their tax liability as soon as possible to prepare," says Barry Kleiman, a CPA and principal at the tax firm Untracht Early. "If money is owed, the balance does not have to be paid until April 15, even if the return is filed earlier."

It's also not a bad idea to consider the worst-case scenario, one in which you have to write an unexpected check to the IRS, Allec says. Take a close look at your budget now to start looking for ways to save money where you can.

Taxpayers should file their returns or estimate their tax liability as soon as possible to prepare.
Barry Kleiman
CPA

"I'm not saying that people necessarily need to alter their entire lifestyle," Allec says. Start with the easy stuff: dine in more, or rent a free movie from the library rather than going out.

If you do end up owing the IRS, don't panic. There are payment plans available if you can't pay your entire tax bill when you file your return. And the IRS has said it may waive penalties if you've paid at least 85 percent of your 2018 tax liability.

Keep in mind that filing an extension will not get you a reprieve. An extension does not extend your time to pay your taxes due, Melwani says. Instead, you'll still have to pay about 90 percent of your tax bill by April 15 to safely avoid penalties.

"The tax authorities have no problem giving anyone until Oct. 15 to file their returns, but they do not want to wait that long to receive 'their' money," he says. "This is definitely one of the most confusing things when it comes to income taxes."

Who's likely to be affected

Here's who's most at risk for a lower refund this year:

  • Those who did not adjust their withholding rates

The largest population of people who will be affected by the tax changes are those who did not adjust their W-4, the form that calculates how much income tax is withheld from every paycheck. An estimated 20 percent of taxpayers did not withhold enough throughout the year, Kleiman says.

The withholding tables were adjusted to reflect the lower tax rates, Kleiman says. But these changes did not take into account other tax law updates such as the reduction in itemized deductions.

End result: "Taxpayers received more in their paychecks but could now see smaller refunds or monies due," Kleiman says.

  • Those with large salaries in states with high taxes

The other group that may see lower refunds is higher income earners in states with high state and local taxes, Melwani says.

Workers in New York, New Jersey, Connecticut, Pennsylvania and California, for example, will probably be paying more in income taxes starting with the 2018 tax year, Melwani says. This is due mostly to the new limitations on deducting state, local and real estate taxes.

Folks with significant itemized deductions such as state and local taxes and unreimbursed business expenses will be more susceptible to smaller refunds or monies due.
Barry Kleiman
CPA

A good example of this scenario, Allec says, is a married couple with a high income in a big house in a high tax state with three adult children still living at home. Let's say they pay $20,000 in state income taxes annually and pay $15,000 in property taxes. Under the old tax system, they could deduct all $35,000 of their combined state income taxes and property taxes as an itemized deduction.

Now their maximum deduction for these combined taxes is only $10,000, Allec says.

Plus, before they would have received dependency exemptions on their three kids, to the tune of $12,150 for all three. Now they're likely receiving nothing, he says. The Tax Cuts and Jobs Act did away with these exemptions and replaced them with an expanded $500 child tax credit. Unfortunately, this couple can't take advantage of that since their kids are adults.

  • Those with work expenses they usually write off

The third big group of people who may be hit harder, Allec says, are those who have a large number of unreimbursed work expenses: uniforms, equipment, travel and vehicle costs, including mileage, for example.

"In general, folks with significant itemized deductions such as state and local taxes and unreimbursed business expenses will be more susceptible to smaller refunds or monies due," Kleiman says.

Under the old rules, you could deduct employee expenses that exceeded 2 percent of your adjusted gross income, Allec says. So if you're making $50,000, and you incurred $5,000 in unreimbursed employee expenses, you could take a $4,000 deduction for these expenses.

"Such a large amount of unreimbursed employee expenses may sound foreign to those with 9-to-5 office jobs, but there are several professions where paying a significant amount of expenses out of pocket is the rule more than the exception: non-commission-based salespeople who have to wine and dine potential customers on their own dime, for example, as well as long-haul truck drivers," Allec says.

Don't miss: 80 percent of people missed a step related to taxes in 2018, and it could affect their refund

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