Why You Shouldn't Celebrate Tax Refunds and How to Plan Better

A tax refund is not just money that falls out of the sky, however much of a windfall you think it may be. All it really means is that you overpaid tax and gave the government an interest-free loan. 

You are just getting back money that you did not owe in the first place. Withhold too much tax and you will get a refund but you could get a far higher return on your money by using it in other ways.

Salaried employees 

Whether individual taxpayers owe the IRS or get money back depends on a document employers use, known as a Form W-4. Employers use the tax withholding tables issued by the IRS to decide how much income tax to pull from an employee’s paycheck. The form includes details such as the individual’s filing status, income generated and number of dependants in a household etc. 

Ideally, the income tax withheld from a paycheck should cover the income tax liability of an employee for the year and so employees should not receive a refund or owe additional taxes. Salaried employees need to take the opportunity to adjust their withholding status with employers so they do not pay more than they owe. 

Employers with financial problems may be withholding tax from employees and then battling to pay it over to the IRS. Fortress Tax Relief offers tax resolution services and has highly competent, trained tax attorneys to help employers build and present a strong case to resolve tax issues. 

The self-employed

For those who need to calculate the amount of tax they withhold themselves, they can use the IRS withholding calculator. The self-employed are supposed to pay quarterly estimated tax on their income. 

It can be difficult to estimate the amount and many people based it on what they paid the previous year, which can be a mistake if changes have occurred. Overall, you want to come as close as you can to matching your liability to the IRS. 

Better ways to use the money

The money you save from not overpaying taxes can be better used, especially if you plan well. 

Start an emergency fund

Most people face unexpected situations that could affect them financially, from ill-health to a divorce or a car accident. It is important to have extra cash available for such situations. The refund you receive from the IRS could mean you do not have money to contribute to an emergency account on a monthly basis. 

For example, if your car needs repairs and you have overpaid the IRS, you may have to borrow money or cut costs elsewhere to fix it instead of using the money you have in your emergency fund. You may only be able to put a small amount into such an account every month but it will accrue over time. 

Pay off high-interest debt

If you receive a big tax refund, it means that you are missing out on being able to use a fair amount of extra money every month. That money could be spent paying down a credit card balance that is costing you plenty of interest annually. You could also use it to pay off a student loan and make sure you stay in good standing on all your debts. 

Open a retirement account

Instead of overpaying in taxes, you could invest money in a retirement fund or if you already have a retirement fund, you could increase the amount you are contributing on a monthly basis. This would mean having more cash available on retirement when you really need it.

Filed under: Life

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