Many taxpayers dread filing tax returns, but some workers are eligible for significant tax refunds each year. Tax refunds result from an overpayment of required taxes. Employers deduct a certain portion of pay from income to cover taxes employees owe to the Internal Revenue Service. If you make less money now than you did in the past, you could potentially get a larger tax refund.
Generally speaking, reduced income may result in placement in a lower tax bracket and possibly a larger tax refund at the end of the year.
Understanding Employer Withholding
Employers withhold taxes from pay based on estimates of your annual salary. In general, workers' salaries tend to increase over time, which means employers will withhold more pay. If your employer expects your annual pay to increase but you end up earning less than expected, the proportion of your pay withheld for taxes might be too high. In this case, you may be entitled to a larger tax refund than if you had earned as much or more than expected.
Assessing Your Estimated Taxes
Self-employed workers do not have taxes withheld by an employer. Instead, business owners and contractors must send estimated tax payments to the IRS each quarter to cover income tax, Social Security taxes and Medicare taxes. Tax estimates are often based the earnings of previous years. If you earn less this year than you have in the past, you might overestimate your tax obligation and pay more to the IRS than required. In this scenario, you will likely receive a larger tax refund than you have in the past.
Changes to W–4 Form
When you take a new job, your employer is required to have you fill out the W-4 tax form, which helps determine how much tax to withhold from your income. If you have taken a new job with lower pay and changed your declaration on Form W-4, it could result in more tax withholding and a larger tax refund. Claiming zero allowances on W–4 form will result in more tax withholding; the more allowances you claim, the lower the tax withholding.
Other Important Considerations
Certain tax credits and tax deductions are only available to taxpayers at the low- and middle-income levels. For instance, the Making Work Pay tax credit and First-Time Homebuyer tax credit phase out as income progresses above $75,000. If you are eligible for tax credits that phase out as income increases, you may receive a larger tax refund at lower levels of income. Ultimately, whether you will get a larger tax refund at a lower income level will depend on your specific tax situation.