Tax refunds are up so far this season, averaging $3,536, up from $2,880 at the same point last year, according to the IRS.
However, that doesn’t necessarily mean much for the more than 100 million taxpayers who have yet to file their 2021 taxes or receive their 2021 refund.
The IRS notes that its weekly statistics can shift dramatically during the initial weeks of the season. Further, comparing last year’s tax season to this season isn’t exactly apples to apples: The season didn’t start until Feb. 12 last year, compared with Jan. 24 this year.
So despite the average refund being hundreds of dollars higher so far this year, the sting of federal income taxes might be unexpectedly worse than in past years for many taxpayers. That is thanks to a few tax law changes and a handful of unusual developments that took place during 2021.
Following are some reasons your federal tax refund might be a little smaller — or your tax bill a little larger — this tax season.
Advance child tax credit payments
For years, families who were eligible for the child tax credit had to wait until tax time to collect. Typically, they would receive the credit as part of their tax refund. Or, they would have the credit applied to their tax bill, reducing what they owed.
However, the American Rescue Plan Act, which became law in March 2021, made the child tax credit advanceable during the back half of 2021 — meaning the IRS paid part of the credit to eligible households in advance. This was great news for millions of American families, as it meant the credit helped pad household budgets every month during the latter half of 2021, instead of requiring those taxpayers to wait and receive the credit all at once this tax season.
However, come tax time, taxpayers who received advance payments of their child tax credit might be in for an unpleasant surprise. Their tax refund could be smaller — or their tax bill larger — in two ways:
- Taxpayers who received advance payments in 2021 will get less of the credit at tax time, possibly resulting in a smaller refund or larger bill.
- Unless taxpayers informed the IRS of their 2021 income during 2021, their advance payments were based on their 2020 or 2019 income. That means taxpayers who ended up earning more income in 2021 than they did in 2020 or 2019 might have to return a portion of their advance payments to the IRS at tax time.
Paused student loan payments
A federal law established in March 2020 — the Coronavirus Aid, Relief, and Economic Security (CARES) Act — allowed borrowers with federally owned student loans to defer their payments. Eligible borrowers could put both principal and interest on hold through September 2020 without being assessed a penalty.
The pause has since been extended through May 1, 2022. All of this sounds like great news, and it certainly is for millions of borrowers. But student loan interest is tax-deductible, whether you itemize your deductions or take the standard deduction.
That means borrowers who typically deduct their student loan interest will not have much — if any — interest to deduct on their taxes this spring if they were not making payments in 2021. And that in turn could mean a slightly smaller refund or slightly larger bill from Uncle Sam.
Paused mortgage payments
The same CARES Act that paused student loan payments also gave many homeowners the option of mortgage forbearance. As with the student loan effort, the mortgage pause has been extended, until as late as 2022 in some cases.
Normally, mortgage interest generally is deductible only if you itemize your tax deductions — which only a sliver of taxpayers have done since the Tax Cuts and Jobs Act of 2017 roughly doubled the standard deduction. Still, some folks do indeed continue to itemize, and if they skipped mortgage payments in 2021, they will have less interest to deduct on their next tax return.
So, this is another instance in which some taxpayers might face a slightly smaller refund or larger bill than they are expecting.
Bigger mutual fund distributions
The stock market had another remarkable year in 2021. If you are an investor, odds are good that your coffers swelled throughout the year.
But America giveth, and Uncle Sam taketh away. Come tax time, you might have to give back some of those gains in the form of taxes, at least if your investments that swelled in 2021 included mutual funds in a taxable account.
Mutual fund companies pass distributions — earnings and other payouts — to shareholders, usually at the end of the year. If you hold your funds in a taxable account like a brokerage account that received such distributions in 2021, you will need to report these distributions and likely pay taxes on them.
Your brokerage firm should send you an IRS Form 1099-DIV with the amounts that you must report on your tax return, or you should be able to log in to your brokerage account online to access the tax form.
However, there is some good news if you invest in a retirement plan like a 401(k) or individual retirement account (IRA): You will not owe taxes on your distributions when filing your next tax return if the distributions stem from investments in that account. The same is true if you are investing money in the market inside a health savings account or other tax-advantaged account.
Unemployment benefits generally are taxable income, as far as Uncle Sam is concerned. But often taxes are not withheld from unemployment payments like they are from employees’ paychecks.
If you received unemployment in 2021 but didn’t request that taxes be withheld from the payments, you might have to pay taxes on the entirety of that income all at once this tax season. That could mean a big dent in your tax refund or an unexpected tax bill if your unemployment benefits comprised a good portion of your 2021 taxable income.
This could come as an especially rude awakening for people who received unemployment in both 2020 and 2021.
The American Rescue Plan Act allowed many taxpayers to exclude up to $10,200 in unemployment benefits from their 2020 income, meaning they didn’t have to pay taxes on it — and therefore received a larger refund or smaller bill than they otherwise would have. But at least as of this writing, Congress has not extended that tax break for 2021.
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