Big Tax Refund? Big No-No!
Tax season comes with a lot of stress, anxiety, and uneasy feelings for many Americans. Many people owe taxes for the previous year, and some plan their summer vacations based on their refund amount. How many of you get excited when you know you will be receiving a “large” tax refund? How many face sleepless nights knowing you owe Uncle Sam? Tax preparation season is one of the busiest times of the year for employers, employees, accountants, and tax preparers. If you are receiving a “large” tax refund this year, continue reading to learn why that might not be the best way to handle your W-2 personal finances.
We can start out with the idea that most people believe taxes generally provide benefits for the greater good of society. Are there wasteful programs? Yes. Are there programs that are under-/over-funded with tax money? Yes. Does each person receive at least some benefit from federal and state taxes? Absolutely! However, we can all agree that none of us want to randomly pay the government (federal, state, or local) more in taxes than we are required. Giving Uncle Sam a 0% interest loan throughout the year and then waiting several weeks/months to receive your money back seems quite antiquated. Surely, there is a better way to keep all your money during the year, and reduce your tax bill to the lowest cost necessary.
Psychology plays a big part in whether or not you like and/or need to receive a large tax refund. For some, an extra $100/month would likely just get spent since most people do not know their monthly expenses (down to the penny!). However, if you receive a large one-time $1,200 check/deposit you are much more likely to save/invest, or use it to go on vacation/stimulate the economy. This means you are giving the government $100 extra each month and then somehow thankful when you receive YOUR money back! The government knows this and this is the reason why they take taxes out of your paycheck BEFORE you see it. Why wouldn’t we get to keep our whole paycheck (short of insurance, retirement, etc.), and then write Uncle Sam a $10,000 check at the end of the year? How many people would honestly be able to pay their tax bill at tax time if they received their whole paycheck? The answer is very few.
There are some jobs like 1099 contractors and sales jobs with commissions/bonuses that make it very difficult to know your exact tax bill. The people in these jobs must be extremely careful because often your paycheck does not have taxes withheld, and therefore at tax time you are faced with a $10k-20K+ tax bill. This has hurt the gig economy workers hard, partly because people did not realize taxes were not being withheld from their side jobs. This caused many people’s tax refund from their W-2 jobs to be completely taken by the taxes owed on their 1099 jobs!
Returning to the main focus of why a large tax refund might be a big no-no, is the fact it is your money that the government took from you. There are ways to reduce your tax burden through the year and while it might be very difficult to get right at $0 refund and $0 tax bill, you can get close. Especially with soaring inflation, being able to use your extra money during the year would significantly help most people’s monthly budget! Sit down with your payroll/HR rep and go through your W-4 withholdings, and see if there are exemptions you can claim during the year to reduce your tax refund.
Personally, I like to get our taxes as close as possible to $500 either as a refund or tax bill; this is a manageable tax bill for us or a little surprise refund. This might not be the case for everyone and I understand that. However, if you are a W-2 employee with no side gigs/businesses, receiving $5K+ as a tax refund can have a significant impact on your monthly budget. Building up credit card debt, not being able to cover monthly bills, not building an emergency fund, etc. can all be caused, in part, by a large tax refund as opposed to getting as much of your paycheck every month as you can. If you’ve received a large tax refund, schedule an appointment with me and we can come up with a SMART plan so that you can stop giving the government free money during the year!
