Smart TaxesSmart Taxes

Tired of giving the government an interest-free loan?

Many people enjoy getting tax refunds. But it makes better financial sense to adjust your withholding and use your money all year. Here's how to do that.

By MSN Money Partner Apr 11, 2013 12:23PM

This post is by Tom Herman of The Wall Street Journal.


Millions of people look forward to receiving their income-tax refunds each year.


Getting a tax refund may seem like a safe and reliable way to force yourself to save. If that's the only way you know how to save, so be it. But for most of us, there is a better option.


As you struggle with your 2012 income-tax returns, consider reviewing your tax withholding, estimated tax payments, or both. If you overpaid your taxes last year and are eligible for a big refund, you may benefit by making some changes for this year. Many people could use the savings to pay down credit-card debt, student loans or other obligations.


The Treasury Department doesn't pay interest on routine refunds. That means taxpayers who collect large refunds year after year have been giving the government an interest-free loan of their money. The IRS says more than 110 million income-tax refunds totaling $309.6 billion were paid last year. The average refund was $2,803.


"For good tax- and cash-planning, it's always a good idea to take a fresh look at your withholdings and estimated taxes, especially when payroll withholding doesn't cover your tax liability," says Bob Meighan, vice president at Intuit's TurboTax. "For example, if you have substantial income not subject to withholding, like investment income, self-employment income, partnership income etc., this becomes even more important."


This can be highly complex, especially in light of tax-law changes enacted in January. Also, there are safe-harbor rules. Thus, you may need software such as TurboTax — or consider asking a tax expert to crunch the numbers and decipher the rules for you. You can find a free tax-withholding calculator on the IRS site, as well as publications on the topic.


On the site, the IRS says: "If you are an employee, the Withholding Calculator can help you determine whether you need to give your employer a new Form W-4, Employee's Withholding Allowance Certificate, to avoid having too much or too little federal income tax withheld from your pay. You can use your results from the calculator to help fill out the form."


Keep in mind that many key tax numbers change each year to reflect inflation. Among these are the standard-deduction amounts. Nearly two-thirds of all taxpayers choose the standard deduction each year, instead of itemizing.


The personal-exemption amount also has changed. For 2013, the personal-exemption amount (which will appear on tax returns to be filed next year) rose to $3,900, from $3,800 for 2012 (the amount shown on returns for 2012 and due to be filed this year). The IRS adds this warning: "However, beginning in 2013, the exemption is subject to a phaseout that begins with adjusted gross incomes of $250,000 ($300,000 for married couples filing jointly). It phases out completely at $372,500 ($422,500 for married couples filing jointly.)"


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