Updated: 4/17/2012 12:20 AM ET|
Why I hate income tax refunds
That big, fat tax refund really means you've given the government an interest-free loan. It's far better to keep the money you earned in the first place.
Refunds: They're wrong!
It's hard to get that through to my clients. But refunds are bad.
Sure, it's exciting to get a check from the Internal Revenue Service. Well, actually, it's from the Treasury, but you know what I mean. That misses the point, however.
It's not like you're gaining anything. That money was always yours. The feds are just giving it back. And that's the point.
When you get a refund, what that really means is that you've given the federal government an interest-free loan. You're just getting your money back.
In fiscal 2010, nearly 52 million taxpayers received refund checks, with an average refund of $3,082, up from $2,683 the year before. No matter how you do the math, that's a whole lot of interest-free dollars (about $160 billion).
An offer you can't refuse?
People just don't learn. They want that check from the government. But I can give you the same deal.
I hereby offer to allow anybody reading this to send me money. I'll take cash, checks, money orders, even food stamps. Send me as much as you want. And I promise -- on my word as MSN Money's tax expert -- that I'll send it back to you next April, without interest.
It sounds silly when you put it that way, doesn't it? But it's no different than getting a tax refund from the IRS.
Some people argue that refunds are a great way to save money. If they never see the dollars in their checks, it's easier to put aside money for, say, that big-screen plasma TV they've been drooling over.
Open your eyes, financial fool! That's what payroll savings deductions are designed to do. Increase your retirement-plan contributions. Buy savings bonds. Or just put an extra $50 per paycheck into a money-market fund.
Here's what I'll do. I'll up the ante on my original deal. Not only will I give you your money back, but I'll add a whopping 1% to your original contribution. That's more than money-market funds are paying. You can't beat that kind of deal.
Aim to withhold just enough
If I can't entice you with my "deal of the decade," what should you do?
Aim for the safe harbors. That's the minimum amount you have to pay during the year to avoid any interest and penalties. There's no interest or penalty if any of the following apply when you file your return:
- You owe less than $1,000.
- You've paid in at least 90% of your 2011 liability.
- You've paid in at least 100% of your prior year's total tax.
If your adjusted gross income (Line 37 on your Form 1040 for 2010) was more than $150,000, you need to pay 110% of your total tax, rather than 100%. So if my 2010 adjusted gross income was $160,000 and my total tax was $10,000, I'd need to pay 110% of that, or $11,000, during 2011 to hit that safe harbor. If I do that, there's no interest or penalty to pay, regardless of how much I owe in April 2012.
If you're paying through withholdings, they are deemed to be paid evenly during the year, regardless of when they are remitted. I have some clients who have nothing withheld during the first 10 months and then meet their safe harbors with November and December withholdings.
If you're making estimated payments, they need be equal or, if your income varies substantially during the year, proportional to the income earned during each quarter. So on a simplistic basis, if I have $100,000 in income earned and $40,000 was earned in the first quarter, I'd need 40% of my tax paid in during that quarter. Technically, it's called the annualized income installment method, and it's a bit more complicated than my example.
See Form 2210 (.pdf file) for the required computations.
If you expect to owe additional taxes, it would be prudent to put those dollars into a money market fund (or send them to me) until needed. At least that way, as opposed to increasing your payments to the IRS, you'll get the interest. Just make sure you hit one of the safe harbors.
And don't get any more big refunds. Refunds are bad, bad, bad! Trust me on this.
VIDEO ON MSN MONEY
In theory Mr. Schnepper is correct, but in reality he is dead wrong for the normal person. He is assuming that you take the extra money every week from your paycheck and put it an interest bearing account (or invest this extra money weekly in the market) and that you won't touch that money until tax time . Basically you wouldn't want to put it in a bank account because the banks really don't pay you interest unless you think 1% is good . Therefore, to really come out ahead you have to invest in the market. Of course, this means you are gambling your money. Let's say your refund would have been $2000. If you consistently got 10% on your money every year, you would only gain approximately $100 a year in interest. This of course is assuming that you actually do take that extra $40 a week, each and every week and invest it in the market (that's probably not going to happen). Now, are you going to be able to invest that money every week without brokerage fees? Those fees must come out of the $100 interest (per se). Of course, the final total profit is also taxed. It's just not worth the risk. Most people at sometime throughout the year would spend the extra $40 a week on something, thereby eliminating that extra cash coming back to you at tax time. This also assumes that you won't touch this build up of extra cash throughout the year too. This scenario just won't happen.
His theory will work well for those that would get a $40K-50K-60K or more in a tax return, but 99.9999% of us don't fall into that category.
These facts above are why in reality, his theory is faulty logic for the average worker. Getting that no interest bearing refund check is a very viable way for the average person to save and get a nice little lump sum handed to them at tax time. The average worker would not normally have that sum available to them at tax time if they didn't let IRS hold their extra cash. Only the rich could afford the risk that he endorses - in theory)
Please don't assume that everyone who qualifies for Earned Income Credit is on welfare. I was divorced when my children were very young. I worked full time and had a part-time job besides, trying to make ends meet. I did not qualify for welfare, food stamps or other government programs, except reduced price lunches at school. I never even applied for the other programs because I knew I was just over the edge. I did, however, qualify for the Earned Income Credit. I used that to pay my property taxes, house insurance and car insurance each year.
Even though I paid no federal income tax as a result, I still paid property taxes, and state, local and school district taxes, as well as sales tax.
My Dad always said..."get as close to zero as you can when it comes to the irs". I agree with that as well...but being middle class and end up paying them sucks as well.
How about the people that just work enough to get a refund check?? You shouldn't be able to get more than what you paid into the system.
Flat tax!! Flat tax!! Flat tax!!
I would rather pay 14% of my total income with no exemptions then have the government pay people for nothing!
When you are a single parent and you have dependants it is really hard to save. Ever since my divorce I have not been able to save anything. I literally live from paycheck to paycheck. The majority of my money goes to the care of them as well as household expenses. I do not eat out and I don't spend foolishly. So it is unfair to assume that anyone can save. How do you save when the last bit of the money that you have left has to go to gas for the week or food? I guess if I were a little more well off then I could see his side of the story. For some of us who are struggling financially there is no such thing as a 401k let alone a savings. When my financial status picks us then I will consider this. But right now it is not a option.
Mr. Schnepper fails to look at reality. For example, a couple receives a refund of $5000, on average that puts $2500 on interest free loan to the government for the full year. $2500 at 1% measly bank rate implies the couple forfeits $25 in forgone interest.
The tradeoff, the extra hundred dollars that goes into their checking account each week gets spent. We all know if it goes in the checking account it we'll find a way to spend it.
Joe Bellavia, CPA
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