Why Your Tax Refund Is Going To Be Smaller This Year


why your tax refund is going to be smaller

Last year was a crazy year for everyone, with the pandemic affecting nearly every aspect of life. However, 2021 is still going to be a weird year for most Americans.

The average tax return last year was $2,616 according to the IRS. That’s bigger than stimulus checks and other help. So many Americans are hoping to receive their tax refunds as soon as possible this year.

But sadly, due to various changes to income and assistance last year, tax refunds for many will be smaller (and could be delayed too – check out our Tax Refund Calendar). Even worse, many could find themselves owing taxes when they’ve never had to owe before. Here’s why there’s a good chance your tax refund is going to be smaller this year.

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Unemployment Compensation

If your tax refund is going to be smaller this year, unemployment compensation may be a big reason why. A variety of programs were launched last year to help Americans who became unemployed due to the Covid-19 pandemic. The biggest program was the CARES Act, which added $600/wk in Federal unemployment to existing state benefits.

Some other unemployment benefits included state benefits (which you could opt to not have your taxes withheld from), or short-term FEMA unemployment benefits. It’s important to remember that unemployment compensation, including this extra $600 per week, is considered taxable income.

However, due to the quick rollout of the extra $600 (and the fact that it came from the federal government versus state governments), many Americans didn’t have any taxes withheld from their unemployment checks.

If you were receiving full $600 deposits, it means you didn’t pay any taxes on this money. As such, when you file your tax return, you’re going to owe taxes on this amount. It could significantly reduce your refund, or even make you owe taxes.

No Student Loan Interest

A popular tax deduction for the 43 million Americans with student loan debt is the student loan interest deduction. To claim this deduction, you must pay at least $600 in student loan interest during the tax year. You can only deduct up to a maximum of $2,500 in interest paid.

The student loan interest deduction is an adjustment of your gross income. So if you earned $60,000 and paid $2,500 in student loan interest, you’ll only pay taxes on $57,500.

However, due to the COVID-19 Student Loan Forbearance, federally-held student loans have been paused since March. These loans have had no payments, and interest has been 0%. As such, most Americans with student loans haven’t paid any interest for 9 months.

The result? You might not qualify to deduct any interest on your taxes – thus increasing your tax bill.

Related: What To Do When Your Student Loans Unpause After COVID-10 Forbearance

A Rise In Side Hustles

With over 31 million Americans becoming unemployed in 2020, a staggering number of people were looking for extra work in the gig economy or by side hustling. However, given this was the first time many of these individuals have worked as contractors, they may be surprised by the tax implications.

Unlike working a job and getting a paycheck, income earned from gig economy work or through self-employment isn’t subject to any tax withholding. Instead, you report your income and expenses at tax time and pay the IRS any tax due.

Sadly, with most people working these gigs because they urgently needed the money, many may not have set any aside for taxes. If you didn’t earn a lot of money (or none at all), you won’t owe much if anything. But if you were making good money on the side, you could have a substantial tax bill.

How To Reduce Your Side Hustle Tax Liability

Before you freak out, make sure that you are properly accounting for both your income and your expenses. As a freelancer or self-employed person, you do have to claim your income, but you also get to deduct any expenses related to that work.

For example, if you’re delivering for Doordash, you would have the following expenses: mileage (57.5 cents per mile for 2020 driving), a percentage of your phone and phone service (maybe 50%), phone accessories you use (like a charger in your car), and other accessories you need for work.

So, if you made $5,000 driving food delivery, that would be your income. But let’s say you drove 5,000 miles on your vehicle to make that money. You would deduct your mileage expense ($0.575 x 5,000) of $2,875, 50% of your cell phone bill which is $300, and $50 in supplies.

After your mileage deduction, you would actually only owe taxes on $1,775 in income. You can then look at your tax bracket and see how much you would owe. If you find yourself owing taxes and can’t pay, the worst thing you can do is avoid it. Check out this guide on what to do if you owe the IRS money.

Important Reminders

First, it’s important to remember that the stimulus checks are NOT taxable. I know this is going to be circulating the internet due to people getting smaller tax returns so I want to debunk that right now. Again, stimulus checks are NOT taxable. It’s free money.

However, if you didn’t get your stimulus check, you can claim your missing stimulus check on your tax return this year. Check out our list of the best tax software to look at your filing options.

Second, more extra unemployment benefits are coming to Americans. If you’re getting the full amount, contact your state’s Unemployment Benefit office to have them start withholding taxes. Otherwise, you may find yourself in a similar situation again next year.

Final Thoughts

The pandemic has been challenging for everyone. And this tax season is going to be no different. With many Americans having new tax situations, this will lead to smaller refunds or even unexpected tax bills

If you find yourself owing money to the IRS that you can’t afford, speak to a tax professional. Beyond addressing your current situation, you’ll want to resolve the underlying issues to avoid future unpleasant tax surprises.



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