Why Your Tax Refund Is Nothing to Celebrate
This is part of our educational blog series, “The Short Form,” to simplify taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
issues and explore the world through the lens of tax policy. Learn more about taxes with TaxEDU.
There are many tax myths circulating on social media, in the news, and even in casual conversations. A common one during tax filing season is that tax refunds are something to celebrate.
What Is a Tax RefundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s.
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Most employers are required to withhold a portion of their employee’s income to send to federal, state, and local governments for personal income taxes. The amount your employer withholds is determined based on your income and filing status (married, single, head of household, etc.), how many allowances you claim, and any additional withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests.
you request. These calculations are based on withholding tables from the Internal Revenue Service (IRS).
If the total you withheld for the year exceeds what you actually end up owing in taxes, you get a refund.
But this isn’t always the case. You may end up owing taxes when you file if the amount withheld from your paycheck was less than what was estimated. Or, if your withholding was accurate, then you could neither owe nor be owed anything.
Rethinking Your Refund
Many of us look forward to receiving a refund when it comes time to file our taxes. A few hundred—or even a few thousand—dollars could pay down credit cards, pay off a bill, cushion your savings, or even fund some pampering or a shopping spree.
It’s nice to get extra money, but only if it’s genuinely “extra money.”
A tax refund is not “extra money.” If you receive a refund, it’s because you over-withheld and gave the government an interest-free loan for the year. If your withholding was accurate and you had that money instead, you could have made money with it by, say, putting it in a savings account or investing in the stock market.
But what if you received a refund last year and owe this year? You might think you paid more in taxes this year (which can be frustrating), but this perception isn’t accurate.
Getting a refund one year and owing the next does not represent your tax burden or how much you paid in taxes. To truly understand how much total income tax was paid, you can look at your Form 1040 to compare how much of your earnings went to taxes versus your total earnings.
So don’t celebrate a large refund or blame tax policy if you owe. It’s most likely a result of your withholding.
Ready to rethink your refund? You can use the IRS Tax Withholding Estimator tool and update your Form W-4 with your employer for more accurate withholding.
Don’t be fooled by tax myths and misconceptions this tax filing season. Explore our TaxEDU resources to learn more about taxes.
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