Filed under: Savings, Lynnette Khalfani-Cox, Money
The IRS reports that 75 percent of taxpayers get a tax refund check each year, and that the average income tax refund is currently about $3,100. Getting a refund check after a year of hard work often feels like a bonus, but isn't a tax refund more like giving the government an interest-free loan?
The reason why you are getting a refund in the first place is because you ended up paying more taxes than you actually owed over the course of the year. That money could have been left in a high-interest savings account or put to some good use.
Consider the following 8 reasons why getting a tax refund check is really not a good idea:
1. The government could seize your money.
Did you know that you could be eagerly awaiting a nice, big tax refund check only to have it snatched away by the government? It's true. When you owe certain debts, the IRS or the U.S. Treasury Department's Financial Management Service, the agency that issues tax refunds, can keep all or part of your refund check as an "offset" against various delinquent debts.
What kind of delinquent bills can put you at risk for having your tax refund check snatched by the feds? Everything from past-due federal or state income taxes to unpaid child support and court-ordered alimony to defaulted federal student loans. Under these circumstances, the IRS can legally keep the refund check you expected to get and apply it instead against your outstanding obligation.
As if that's not bad enough, here's something else that might seem even more galling.
Even though you personally might not have any such debts outstanding, if your spouse does - and the two of you filed a joint income tax return - your refund check could still be tapped to satisfy your husband or wife's debts. If that happens, and you're not legally responsible for your spouse's debts, you might be able to get a portion of the refund check doled out to you by filling out IRS Form 8379 and claiming injured spouse relief. But good luck proving your claim to the Tax Man. And even if you are successful, don't expect that partial refund check to be quickly sent to you either.
2. Other fees could bite into your tax refund.
Be honest: Have you ever used a "rapid refund" service or taken out one of those "rapid anticipation loans" to get your tax refund check faster? If so, you probably paid high fees for the privilege of getting that cash quickly. Experts say the price tag for fast tax-refund loans rival payday loans, and can run as much as 250% in interest or more.
This one really baffles me. But it happens year in and year out. During tax season - starting in January when the W-2's start rolling in and right up until the mid April tax-filing deadline - some people get a sense of urgency about getting their money back from the government. Mind you, these are the very same people who had no problem letting the feds hold their money all year long.
But now, all of a sudden, many people expecting a large refund will pay steep fees to rapid refund services and rapid anticipation loan providers just to get a refund check a few days faster. Electronic filing is free and easy with the IRS, and e-filing using direct deposit already gets you a refund check very quickly, typically in 8 to 10 days. But impatience, financial imprudence - and I suppose, economic desperation - drive some tax payers to unnecessarily fork over even more of their hard-earned money just to more quickly get their hands on a refund check.
3. The IRS got over on you by not paying you any interest.
Isn't it just like the federal government to make one set of rules for itself and another set of rules for you and I? Of course, these rules are designed to fatten the government's coffers and wring the most money possible out of us taxpayers.
That's essentially what happens when the government has to issue a tax refund check. The feds don't pony up any interest to you, even though you let the government sit on your money for nearly a full year. But you can be sure that when the shoe is on the other foot - and you owe money - the IRS will calculate to the penny every bit of money you must cough up -- and will tack interest on top of it.
For example, when you owe the IRS and you don't pay your full tax bill by April 15th, the penalty for failing to pay is 0.5% of your unpaid taxes per month, up to a maximum of 25%.
The penalty for failing to file your taxes is 10 times worse: it's 5% of your unpaid taxes per month, up to a cap of 25%.
Since the IRS makes us pay interest for being late on a tax bill, why doesn't it do the same thing and pay us interest when the feds owe us a refund? I guess what's good for the goose isn't good for the gander.
4. You goofed in calculating your estimated taxes or withholding allowances.
Regardless of whether you're an entrepreneur who pays estimated quarterly taxes or an employee who has taxes taken out of your paycheck, if you're getting a large tax refund check that means you've miscalculated your deductions, exemptions or withholding information and need to re-assess your tax figures.
Small business owners should review their deductions, more accurately estimate business expenses, and make sure they're not overpaying the government each quarter. Employees should use the IRS Withholding Calculator to determine if they need to give their employer a new W-4, Employee's Withholding Allowance Certificate. By tweaking your withholdings, your employer will take fewer tax dollars out of your paycheck each pay period. For more information on this topic, check out IRS Publication 919, How Do I Adjust My Tax Withholding?
5. The tax refund feels like a bonus - but isn't.
Remember that the money the government is sending back to you is money you already earned. You overpaid a bill and are now getting some of those funds back. If the refund was a real bonus, you would be paying less in taxes and/or receiving the money as a "gift" from the government.
6. You could have paid down debt.
If you had been paying the right amount of taxes over the course of the year, you could have used it to pay down some of your high-interest debt more quickly. You could go ahead and pay down some debt in one lump sum when you receive your tax refund check, but you've probably already accrued some interest on your debt balances over the course of the year. Besides paying debt, here are some other smart ways to use your income tax refund check.
7. You're not paying fewer taxes.
Some people make the mistake of believing that they are paying fewer taxes because they got a large refund this year. The truth is, your tax rate is still the same and is based on your income level. You haven't "tricked the system" because you are getting a big refund. You are still paying your taxes like everyone else. You simply ended up overpaying this year and are getting your own money back.
8. The refund isn't a short-term savings plan.
If you are looking forward to a big refund because you want to put it towards a new savings account or set up an emergency fund, you may be fooling yourself into thinking this is the best strategy for doing so. But the best of intentions can go awry. And studies show that although many people say they plan to use income tax refund checks to boost savings or pay off debt, often times the money simply gets spent.
What all this shows is that clearly it's not a good decision to get a tax refund check. Instead of giving the government an interest-free loan, make sure an appropriate amount of taxes are being paid quarterly (for entrepreneurs) or taken out of each paycheck (for employees).
If you routinely get a big tax refund check, it might feel like the IRS is handing you a yearly financial windfall. But the truth is that waiting around for your own money to be returned to you can be risky, costly and financially foolish.