At this point, some people have already filed their 2023 taxes. And if you noticed that your refund this year is smaller than it was last year, you're in good company.
As of Feb. 2, the average tax refund this tax season was $1,395. But around the same time last year, the average tax refund was much higher at $1,963.
To be fair, we're only a few weeks into the 2024 tax-filing season, so this year's refunds may catch up to last year's as more tax returns start rolling in. But here's why your tax refund may be smaller this year than in 2023.
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When your income rises
If you earned more money in 2023 than you did in 2022, then you may be in line for a smaller tax refund this filing season. But those earnings don't necessarily have to stem from a job.
One interesting and positive thing that happened in 2023 was that banks started to pay more interest in savings accounts and CDs in the wake of the Federal Reserve's string of interest rate hikes. But you may not realize that interest income is taxable.
Not only do you have to pay taxes on the interest you earn from a savings account or CD, but in that case, you're charged your ordinary income tax rate -- meaning, you're taxed at the highest rate possible based on your bracket.
As a reminder, the U.S. tax system is a marginal one, where your highest dollars of earnings are taxed at a higher rate than your lowest dollars of earnings. For example, if you're single, earning $50,000 this year, your earnings above $47,151 will be subject to a 22% tax rate. Lower earnings will be taxed at a lower rate.
But interest income is taxed as unfavorably as possible. So if you earned a lot in your bank account last year, it could result in a slashed refund.
A smaller refund isn't necessarily a bad thing
The idea of a smaller tax refund may be upsetting. But one thing you should realize is that a smaller refund means you let the IRS hang onto less of your money in 2023.
When you get a refund, the IRS isn't giving you a gift. It's simply returning money of yours it kept from you previously.
So let's say you got a $900 tax refund in 2023 and are only looking at a $600 tax refund in 2024. You might think you're losing out on $300. But in reality, what happened was that you didn't let the IRS keep $300 of your earnings last year when you were entitled to that money.
Of course, a smaller tax refund can be a blow if you count on a larger sum to do things like cover bills and pay off debt. In general, it's best not to make financial plans around a tax refund since it can be difficult to know what that sum will amount to. But still, if you're looking at less money back from the IRS this year, there are different ways you can cope.
One option is to pick up a side hustle and boost your income that way. You could also take inventory at home and try to sell some unwanted items for extra cash. Finally, simply cutting your spending a bit could free up extra money for essential bills.
There's no guarantee that your tax refund will be smaller this year than last year, so don't assume that will be the case for you. But given that the average tax refund is already notably smaller this year than last, it's a possibility to prepare for.
Your best bet, though, is to file your 2023 taxes as soon as possible. That way, you'll know for sure how much money to expect back from the IRS. And from there, you can adjust your financial plans accordingly.
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