Tax Refunds - Yay or Nay?
I’m sure your first reaction to this title was “Well, YAY, of course! I want a big, fat refund!” So, let’s chat about it!
You are required to pay a portion of your income to the federal (and/or state) government as an income tax. Ours is a pay-as-you-go system, so most of us pay in throughout the year via withholding from our paychecks. At the end of the year, you prepare a tax return that shows how much you actually owe in taxes. If it's more than you paid in, you get a refund. If it is less, than you owe more. It's not that complicated.
Big refunds usually mean you gave the IRS an interest-free loan during the year. It is YOUR money that you are getting back as a refund. If you owe $5,000 in taxes and you paid in $10,000, you're getting a $5,000 refund. If you paid in $2,000, then you owe $3,000. Now, some people like it this way, and that’s fine. If you’re unable to save money, then getting that big refund all at once can pad your savings account… or you can go buy a new big screen t.v. Some people would rather keep their money as long as possible so that THEY can invest it, save it, etc. Honestly, that’s your business.
Now, in the past few decades, there has been an increase in huge tax credits, including child tax credits, earned income tax credits, and education credits. If you are eligible for these credits, then that amount comes off the tax you owe and could result in a refund that was not your money before but it is now. It is still only a refund if you paid in taxes (unless your income is so low you don't owe taxes). Some tax credits are non-refundable, such as the energy credits. If you owe taxes, then the credit reduces that amount to $0 but does not generate a refund. A refundable tax credit like the child tax credit can take your tax bill below $0 and give you a refund.
BTW, tax credits are one of the biggest areas of tax fraud and the IRS is CRACKING down on them.
For example, let's look at a client that would have owed $6,000 in tax. After credits, they owed just under $900. HOWEVER, they had paid IN almost $6,000 in withholding, so they would receive a just over $5,000 refund. Here is where it gets fun - IF they hadn't paid anything in during the year, they would have owed the $900 (no refund).
Now, naturally you want to take advantage of every deduction and credit possibly available to you. That's what pros do - we are working for YOU, not for the IRS. But whether or not you get a refund and how much it is will depend (for most of us) on how much you paid in during the year.
My job, as I see it, is to get the amount of tax that you owe as low as possible within legal and ethical boundaries. Period. If you get a refund, then that's a happy bonus. Even if you don't get a refund because you didn't pay in enough during the year, but you still owe less than you might have otherwise, then I've done my job well.
The Fine Print
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. IRS Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in the entries in this blog (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
