James de Bree | The Incredible Shrinking Tax Refund

Jim de Bree
Jim de Bree

This past year the IRS implemented two politically motivated administrative changes that affect taxpayers. The first, which has received considerable attention, is the change in withholding policies. The second is the postcard-sized Form 1040. Both are backfiring on the IRS.

I am reminded of a time 40 years ago, early in my career, when I prepared a considerable number of individual tax returns. Those who are old enough to recall that era remember that it was a period of high inflation when you could earn a decent return from a savings account.

Most of my clients were happy to get large refunds and judged the competency of their tax preparer not based on the overall amount of tax they paid, but rather on the size of refund they received. Many taxpayers would rather give the government an interest-free loan because they lacked the discipline to save and the extra withholding that generated the refund was a way of forced saving.

I advised my clients to base their withholding on the amount of tax they actually expected to pay and put the difference in a savings account. In those days, paychecks were not directly deposited into employees’ bank accounts. Instead, employees had to deposit their paychecks and then transfer funds to their savings accounts without the benefits of ATMs. 

My clients generally thought my suggestion had merit and many implemented it. 

The following year, I found that most clients who reduced their withholding transferred the reductions to their savings accounts for only a few weeks. Either because of difficulty of making the transfer, or because they wanted to spend the money, most did not transfer very much of the reduced withholding into their savings accounts. In fact, several forgot that they actually reduced their withholding.

When I prepared their subsequent year tax returns, these clients were shocked that they did not get the refund that they were accustomed to receiving in prior years. 

When I reminded them of the strategy we had discussed in the prior year, many thought I was a lousy accountant for suggesting the idea. Fortunately, my career took a turn to serving more sophisticated taxpayers, but I was haunted by the concept that most Americans want to get a tax refund and do not care about loaning money to the government interest-free.

Last year, the Treasury Department decided that the tax cuts needed to be put into the economy immediately and instructed the IRS to reduce the amount of taxes withheld to minimize refunds. Few people were aware of this. Many taxpayers believed that the average person was getting a large tax cut and harbored the illusion that, even though their withholding was reduced, they were still going to get a large refund.

Midway through the year, tax practitioners realized this and encouraged the IRS to announce that the new withholding rates would likely result in lower refunds or perhaps a balance due for many taxpayers. The IRS subsequently made this announcement, which was largely ignored. 

Those responsible for altering the withholding mechanics are learning the same lesson that I learned 40 years ago. Political fallout may result.

The second politically motivated change that is frustrating tax practitioners is the so-called postcard-size tax return. For the last 25 years, Republicans have claimed they want to simplify the Internal Revenue Code so that everyone can file their tax return on a postcard.

In prior years, the IRS had multiple versions of Form 1040, depending on the complexity of a taxpayer’s situation. Millions of taxpayers filed using the one-page Form 1040-EZ. People with complex returns filed using the traditional Form 1040, which was a two-page form. 

This year, there is a one-size-fits-all Form 1040 that is a half-page on both sides. Other than changing the size of the form, not much has changed for the millions of taxpayers who formerly filed Form 1040-EZ. However, for those with more complex returns, there now are six additional schedules which are used to report information that was previously reported on the two-page Form 1040. 

Most tax practitioners who prepare complex individual returns find the new form annoying. Although most returns are prepared using computer software, the output must be reviewed before a tax return is finalized and filed. These additional schedules have made such reviews more tedious, thereby increasing the likelihood that errors will be missed. 

This tax season has shown that political interference with routine IRS practice and procedure is counterproductive.

I want to conclude this column by acknowledging Steve Lunetta’s recent column in which he made kind comments about my previous columns on tax policy, changing his views to more closely align with mine.

Jim de Bree is a semi-retired CPA who resides in Valencia.

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