The Real Problem With Tax Refunds

May 15, 2019

Did you get a tax refund this year?

 

Maybe you look forward to getting a tax refund every year. Maybe you pay off some credit cards with it, other times you take a little vacation, do a small home renovation project or make another large purchase.

It’s almost like a savings account, right? Or better, an annual bonus payment!

But then you have this know-it-alI friend at work that says you’re giving the government a free loan. Are they right?

Well, back when savings accounts were paying 5%, your friends had a point.

But at today’s rates, the interest lost is minimal.

What bothers me is not that people get tax refunds, but why.

Most of the time a tax refund is symptomatic of a person who doesn't have a financial plan, but who has a financial reaction. And the only way reacting beats planning is if you’re lucky.

People like tax refunds for the same reason they like Christmas and birthdays. They know there’s a gift of some sort coming, but they still act like it’s a big surprise.

Usually people enjoy tax returns because they have devised no other method of saving money. And while it’s true this is certainly one way you can save money, it isn’t that far removed for authorizing a thief to steal from you each paycheck and give it back to you a year later.

Surely there must be a better way.

If you earn a predictable salary or hourly wage, work with a CPA or other tax professional to calculate your income tax liability for the year for both the federal and state income tax. Then divide that federal and state income tax liability by the number of times you get paid per year. Next, go to your employer with that per-pay-period tax liability number and tell them you want that much withheld from your paycheck and no more.

If you are a business owner or sales professional, and your income is variable from month to month and year to year, you probably have to pay your income taxes on a quarterly basis, rather than so-much coming out of your paycheck each month.

Either way, work with your CPA or other tax professional to calculate the minimum amount you must send to the IRS each quarter. But while you are minimizing the actual quarterly payment to the IRS, ask your CPA’s advice for how much additional to set aside into a special “tax account” so that when time comes to settle up with the IRS each April 15, you’ll have the funds to do so.

The big red flag for me with large tax refunds is that they indicate a failure to plan.

Retailers know that income tax refunds are the primary method many people use to save money. That’s why they run ads every spring offering to sell you cars, furniture and other big tickets items based on your tax refund. They figure if you haven’t made a plan for what to do with your money, they stand a pretty good chance of talking you out of it.

Did you get a tax refund this year? Great. Buy an hour of your CPA’s time and make sure it doesn’t happen again next year.

Offering you Wisdom on Wealth, I’m Byron Moore.