People love getting big tax refunds. In fact, one of the busiest seasons for bankruptcy attorneys is tax season. Why? Because people will use their refunds to pay a bankruptcy attorney to discharge their debts.
But is it good to get a big tax refund?
It might feel nice to have the IRS put that money in your pocket—but that doesn’t mean it’s a good thing. In this blog post, we’ll explore why receiving a large tax refund is a bad thing and how you can avoid having it happen to you.
What actually happens when you receive a tax refund?
To answer the question, “Why is receiving a large tax refund a bad thing?” let’s take a look at what a tax refund actually means.
If you work for an employer, over the course of the year, you automatically set aside a portion of each paycheck, not just to cover your share of employer-provided benefits such as healthcare or your contributions to your retirement fund, but also to cover your state and federal income tax payments. Often, the amount you set aside is more than you’ll need to pay your fair share. In that case, the IRS will return the excess to you after you file your taxes.
In other words, when you receive a big tax refund from the IRS, they are just sending money back to you that you overpaid them throughout the year. When you receive a big tax refund, you’re just using the IRS as a forced savings account that you can only withdraw from once a year!
If you get a $4,000 refund, that means you diverted $333.33 of your income per month to the IRS you could have used throughout the year. You’ve given the IRS a 0% interest short-term loan!
So, in short—getting a small tax refund is normal, but is it good to get a big tax refund? It might feel good at the time, but no—you could have done much more with that money if you’d kept it.
Is it better to owe or get a refund?
We’ve been talking about why getting a large tax refund is bad, but let’s not lose sight of the fact that, generally, owing taxes is not good, either. Under-withholding can leave you with more money now, with the downside of having to pay the IRS after filing your taxes. If you’re not prepared to pay the IRS a lump sum for owed taxes when the bill comes, you can find yourself placed under significant financial strain, and if you owe too much, you could even incur penalties or interest.
Here’s an example where overpaying the IRS is a bad idea. If you owe the IRS back taxes or have defaulted on your federal student loans, the government can garnish your tax refund to repay your debt. While you should always repay your debts, it would have been better to have that $333.33 during the year to put toward your monthly debts and save all those late payment penalties and interest on your taxes and student loans.
What’s the best way to do your taxes to avoid large refunds?
If you got a big tax refund from the IRS after doing your taxes this year, what can you do to ensure you keep the majority of that money for next year?
It takes more careful planning, but it can be done. If you work for an employer, look closely at your Form W-4 and update it to either claim more allowances or directly adjust the withholding amount. If you’re self-employed or have significant income that is not subject to withholding, adjust your quarterly estimated tax payments.
In a perfect world, nobody would overpay or underpay their taxes—we’d pay exactly as much as we owe every time. But unfortunately, we do not live in a perfect world with a perfect tax code. Our tax code is notoriously hard to understand, and knowing how to get the best tax return isn’t a responsibility the system leaves to ordinary taxpayers. To avoid owing taxes and excessive refunds, you’ll have to turn to tax accountants who can help you hit that sweet spot and meet your own financial goals.
If you’ve found yourself struggling with mounting penalties or interest from owed taxes and don’t know what to do, don’t turn to accountants—that’s where tax attorneys come in. Call us today at (404) 233-9800 or fill out our online consultation form to schedule a meeting with one of our tax attorneys.