Refund or payment in taxes for 2018

Like most people with professional jobs, we have some money squirreled away in the stock market so come tax season, we’ve to wait until February 15th to finalize our tax returns.

After a few years of eagerly waiting for refunds and realizing the futility of that behavioral economics-driven contradiction, we adjusted our withholding to ensure that we have to pay a minimal amount each year instead of letting the government earn interest. The withholding tables and advice from our employer where we have now worked for 6+ years via an online tool helped us keep it to a low amount so it didn’t break our bank or lead to unexpected surprises.

This year, however, we were in for a surprise.

As most know, 2018 wasn’t your normal year in terms of taxes. The Republicans passed a tax reforms package that promised lower taxes and more money in your pocket. But what they did, in complete disregard to how Americans view their tax returns, is to pad everyone’s monthly paychecks with a little extra. They achieved this by changing the withholding amounts which makes economic sense but only in the world where everyone is a rational being.

That theory has been debunked over and over again and humans can be frustratingly irrational. So in that sense, most Americans expect a refund to an average of $2,700. But this year, it turns out many Americans not only will not get a refund that large but will also in a sharp departure from earlier years, will have to cough up a payment.

Coming back to our personal case, even after controlling for change in income, the amount we owe is 40% higher than previous years. Thankfully in gross terms, it’s not much to cause us financial difficulty since we save up for such contingencies 1. But for most Americans, it’s going to be very difficult. Imagine going from expecting a refund to finally make a downpayment on a car to now having to dip into your saving or worse, borrow from elsewhere to pay your taxes.

For us, it was not only the ambiguity of withholding amounts but also the loss of personal exemptions that caused this increase. Although the standard deduction has been doubled to $24,000, combining our mortgage interest deduction, personal exemptions, and other itemized deductions, we would’ve come out much higher than the doubling of standard deductions. We have only one kid so I can imagine the calculations for our neighbors with larger families. Of course, for someone who is single or married with no kids and renting (or owns their house outright), this tax reform would be great news and good for them.

In a sharp departure from bipartisan consensus, this tax reform may, for the first time, have de-emphasized home ownership. This aspect is often ignored in most discussions of the reforms. Going from unfettered access to credit that led to a spate of buying multiple homes, we have now made a drastic U-turn in capping mortgage interest deductions for low-value homes while preserved the benefits for high-income homebuyers. Effectively, the decision for Married Filing Jointly’ to itemize or to claim the standard deduction in 2018 depends on whether their mortgage balance is 560,000 or more assuming the current national average rate of 4.3%.

How this will play out in terms of other policy priorities over the next 5-10 years remains to be seen. For now, there are plenty of irate Republican voters on social media vowing to never vote for Trump.

  1. Conveniently for us, this year, we’re expecting a tax credit for our solar panels so we will be getting a refund. But that won’t be true next year.

February 16, 2019 · personal · taxes

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