5 Reasons Why A Big Refund Is A Bad Idea
by Wayne M. Davies
I will never forget the day one of my tax clients came to
pick up his personal income tax return.
"How's it look?" he asked.
"Well," I said, "You're getting a refund."
"Great! How much?"
"Oh, it's a big one," I said. "Over $5,000 dollars."
Mr. Taxpayer couldn't have been happier. He face lit up like a light bulb.
He was ecstatic -- he sincerely believed that he had "beat the tax man" by
getting such a large refund.
I was not so happy. I couldn't understand his thinking. So I asked him if
he really intended to get such a big refund. Mr. Taxpayer was a W-2
employee and so I wondered if his payroll department made a mistake -- were they
doing his withholdings wrong? Did he really want to have so much tax taken
out of his paycheck each week?
Mr. Taxpayer went on to tell me that he has a tremendous fear of having a
balance due on his return. For some reason, he just assumed that if he
ended up owing money to the government at the end of the year, somehow he would
get in trouble with the IRS. So he went to the opposite extreme.
In addition, he thought that getting a big refund was a great way to save money
during the year, so that at the end of the year he got a nice little "bonus"
from the government. You know, a forced savings plan.
I can think of at least 5 reasons why Mr. Taxpayer's thinking is flawed.
REASON #1: When you get a big refund, you are lending your money to the
government.
My biggest objection to getting a large refund is the simple fact that you have
given the IRS an interest-free loan of your hard-earned money.
Mr. Taxpayer's $5,000 could have been earning interest over the course of the
year. So by letting the government keep his money, he was actually losing
money!
Sure, with rates so low, maybe we're not talking about a lot of interest income
here, but why give the government your money any sooner than necessary?
REASON #2: Getting a big refund does not mean you are paying less tax.
I know how complicated our tax system is. It's crazy, convoluted, chaotic
and inconsistent. I deal with our tax laws every day, and there's stuff in there
that will drive any sane person over the edge.
But on this point, there really is a lot of misunderstanding on the part of
innocent (but misinformed) taxpayers:
Getting a large refund does not mean that you somehow paid less tax than if you
got no refund.
I'm serious here -- there are taxpayers out there who think that getting a
refund means that you somehow "beat the system." This is nonsense. Think about
it -- all you did was get your own money back! It was your money all along, all
you did was postpone getting it.
REASON #3: Having a balance due does not increase the chance of an audit.
If you have a balance due, you do NOT end up on some IRS "hit list." But for
some reason there are many taxpayers who have this unfounded fear of owing money
to the government. This fear causes people to unnecessarily go to the opposite
extreme -- "I've got to make sure I never owe, so I'll just have way too much
withheld to be safe."
Safe from what? This fear of an audit is pure hogwash.
REASON #4: Getting a large refund is usually a sign of poor (or non-existent)
tax planning.
Many folks do not realize how easy it is to get out of the "big refund rut".
You have control over how much you pay in to the IRS during the year. If
you or your spouse are W-2 employees, you can change your withholdings very
easily. Just file a new Form W-4 with your employer and you won't have to
wait so long to get your money back.
If you are self-employed and making quarterly estimated tax payments, the same
principle applies. With a little number- crunching you can determine the minimum
amount of estimated tax payments you are required to make.
Whether you are self-employed or work for someone else, if you're not sure how
to do these calculations, get help from your local tax professional.
REASON #5: Getting a large refund is usually a sign of poor (or non-existent)
financial planning.
My client insisted that he needed a large refund so he could have a nice nest
egg to look forward to every Spring. He was using the government as his
short-term savings plan.
I told Mr. Taxpayer this:
"If you want to save $5,000 dollars over the course of the year, just authorize
your employer to deposit $100 per week into your savings account. Then at
the end of the year, your $5,000 will be sitting in your own bank account
instead of at the U.S. Treasury.
And you won't be in such a frantic frenzy to get your tax return filed."
So I urge you to reconsider such an approach to money- management. Why let
the government have your money? Don't wait until the end of the year to
get your money back. With a little planning and self-discipline, you can take
control of this part of your life. Wayne M. Davies is author of 3 tax-slashing
eBooks for the self-employed, available separately or as a 3-volume set, "The
Ultimate Small Business Tax Reduction Guide".
http://www.YouSaveOnTaxes.com/ultimate-guide
To get your free copy of Wayne's 25-page report, "How To Instantly Double Your
Deductions" visit:
http://www.YouSaveOnTaxes.com