As the end of the tax season quickly approaches, numerous commercials advertise how clients receive a $500, $1,000, or even $2,000 tax refund. It is always welcome to receive this extra cash back from the IRS. Some use it to help finish off paying a Christmas that went a little over budget or towards the purchase of new television or the latest tech gadget they been waiting patiently to purchase. But here’s the catch — it is your money you are getting back. Money you could have been using all year long.
Think of it this way. The Federal Government sets up tab for each taxpayer. With each paycheck or estimated payment, taxpayers pay towards their tax bill. At the end of the year, taxpayers settle up with the Federal government by filing their tax return. If you overpaid, you get a refund.
In 2011, the IRS paid over $338 billion in refunds to individuals. While it is better to get a refund than to owe more in taxes here are some reasons why you don’t want a tax refund.
1. More Money through the Year
If you are living month to month or would just like a little more each month making an adjustment to your withholding amount could provide that slight extra you need. A large tax refund often means you are having too much withheld from your paychecks in taxes during the year.
2. Invest and Earn
Your tax payments made during the year are like an investment in the Federal government that pays no interest. Adjusting your withholding amount may provide the ability to invest that extra money and earn interest.
“While cash yields today are at historic lows, this hasn’t always been the case. CD rates over the past 20 years have averaged 4-5%,” said Andrew Russell, Certified Financial Planner with Dean Roland Russell Family Wealth Management. “Long-term investors may consider investing a portion of their savings in the stock market. The long-term average return of the S&P 500 is around 10%. So far year-to-date the S&P 500 has returned 12.88%”.
3. Payoff high interest debt
It is estimated that Americans have an average of $6,500 in credit card debt with an average annual percentage rate of 15 percent. As stated before, you are not earning any interest on tax payments made during the year to the Federal government, so taxpayers with credit card debt may actually be losing money by receiving large refunds because of interest charges on credit card debt.
How to Change Your Withholding
With simple tax planning, you can adjust your withholding amounts to better estimate your tax bill and get you closer to that breakeven point – no tax refund, no taxes due.
First step, grab your Form 1040 returns from the last few years. Look at line 44. This is the amount of tax you owed. Depending on personal life changes that occurred during those years, like having a child, starting your own business, or becoming a homeowner, those numbers may be similar. Unless the tax code changes, these will provide with you an estimate of how much tax you should expect to pay.
Next step, review you the number of allowances claimed on your W-4 filed with your employer. If you are receiving a large refund, you may want to increase the number of allowances by submitting a new W-4 with your employer.
For more information contact your local tax professional or read IRS Publication 919: How Do I Adjust My Tax Withholding?
When changing your allowance amount, it is important to remember that if you do not pay enough in taxes throughout the year you may be charged an underpayment penalty. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.
The penalty for underpayment of estimated tax is figured at the annual rate of 4% for the number of days the underpayment remained unpaid.