Many people often get upset when a coworker with a similar salary, financial situation and home life gets a much larger tax refund. It could even be the case the coworker has the exact same salary, number of kids, rent v. owning home, and any other relevant factor but yet still receives a bigger tax refund. The first instinct is normally to blame the tax preparer for not finding enough “deductions” or other beneficial factors that the person believes the coworker must be receiving. However, usually the explanation is much simpler than that.
When you first start a new job you have to complete a Form W-4. This form is an overview of your tax situation and helps your employer determine how much in taxes they should withhold from your paycheck – it should be emphasized that this is only an estimation. In our scenario with the two coworkers that have all the same relevant factors, the W-4 should look exactly the same, however, based on advice from a CPA, tax professional, or even an uniformed friend, one of the coworkers may have entered information differently than the form suggests. The form is merely a method for the employee to estimate, but the employee is free to make their own determinations. In extreme circumstances an employee could even mark the W-4 “Exempt” and not have any income taxes withheld.
Therefore, if two coworkers estimate their taxes differently on Form W-4 they will have different amounts taken out of their respective paychecks throughout the year. At tax time, the tax returns may calculate the same amount of tax based on income, however, one coworker has had more than that withheld from their paychecks and the other has not had enough – leaving one person with a refund and the other with a bill. Nevertheless, the total amount paid is exactly the same. One coworker is paying the taxes more throughout the year while the other is paying less during the year with a larger lump sum at the end.
If you truly want to know what is really going on the number to be compared is total tax on the tax return, not the refund or amount due, because this will show how skilled the tax preparer is or isn’t. Overall, a large tax refund can sometimes mean poor tax planning because the taxpayer is paying in too much tax during the year and depriving themselves the benefit of having that money until the following year’s tax refund. On the other hand, the person with a small refund or a tax bill, assuming no penalty, has actually had the benefit of having their money during the year and only giving the IRS exactly what they need.
If you have any questions about your tax return, Form W-4, or any related issues, contact us at Hone Maxwell LLP. Also, you can follow us on twitter @HMLLPTax or facebook at www.facebook.com/HoneMaxwellLLP for more tax tips and the latest updates on tax news.