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
So I get a $2000 refund. With bank interest rates well below 1%, how much money am I loosing?
Not enough to endure the hassles and expenses of moving money each month.
Um, guys, for those that misses the whole point of this article:
This is all about financial planning. Even down to the part of not using up the last 100 of your checking account every month. Obviously, if you are one of those people who cannot resist the urge to spend every last dime of your money each time, then this article doesn't applies to you.
It makes financial sense to have full control over your financial future instead of letting the government take away the extra money away from you. You do not have to be a millionare or earn 100k above to do this. By the way, 10% of 2000 is $200 dollars, not $100 like what some users said. Let's just say you owed $2000 in taxes and instead of letting the government taking it every month, you invested it in a money market fund and managed to get $200 at the end of the year, you have effectively lowered your tax from $2000 to $1800.
Obviously, if you are the kind of person who can never control your spending, then yes, you should let the government take ahold of your money since these are the only way you can 'save.' But if you really want to get out of the 'living from paycheck to paycheck' scene every day for the rest of your life, obviously, something need to change.
This is actually what the author is trying to do by raising awareness and giving sound advice on money management. By no means, this is the only thing you can do to lower your debt.
Again, this bear repeating, financial planning and budgeting is the key to all of these. I'm not saying that it is the panacea to all financial troubles, but it will definitely help a lot.
If you can afford to take the tax out, fine. If you can't, that's okay too. We just don't like letting the government using our money to loan..their track record is not exactly outstanding.
This is good information for some people. As for me, I have never overpaid the government. During the last 3 years, our wonderful Treasury Dept. has given me and my family approximately $25,000, not because I overpaid them. The only deductions that have come from my check has been the mandatory FICA contributions. This 'gift' money as I call it, has been bestowed upon me due to our countries relaxed tax laws, as well as a bad idea that has been gaining momentum for decades, that states nearly everyone should be receiving some form of government assistance. Thank You Treasury Department ! I must admit that I feel a little uneasy about accepting the money, due to the fact that I know it is borrowed. Someday it will have to be paid back. As a country we will either give our assets to our debtors, or my children will be the repayors of the debt. Anyway you figure it, our nations fiscal state is beyond critical.
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