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As a self-employed person, getting a tax refund is a rare event in my world. Most years, I wind up having to pay the IRS a sum of money once my tax return is completed.
The reason is because I don't have taxes withheld from my earnings. Rather, I make an estimated tax payment every quarter based on what I think my total income for the year will be. And often, I get that number wrong and get stuck having to transfer a large sum of money out of my checking account and over to the IRS in April.
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I was discussing that situation with a friend earlier this year when she said something along the lines of, "Wow, that stinks." I then asked her what her most recent tax refund looked like, and she said it was somewhere in the ballpark of $2,000.
My response to that? "Wow, that stinks."
Why tax refunds aren't a good thing
It's a big misconception that getting a tax refund is something to celebrate. The reality is that a tax refund represents money you were entitled to collect sooner based on your earnings, only you gave it to the IRS to hang onto for a period of time instead -- interest-free.
Let's say you wind up with a $2,000 tax refund. It means you paid the IRS $2,000 more than you had to the previous year. That's not a small amount of money to wait to collect. And that $2,000 perhaps could've made your life easier during the year had you received a portion of it month after month.
In fact, let's say money gets tight, so you decide to trim a $50 expense from your monthly budget. Chances are, if you were getting all of the money you're entitled to from your paycheck up front, you wouldn't be in that situation. Instead, you'd have the extra $50 a month coming in.
And that's why you really shouldn't want a refund. It may seem like a nice thing to get a lump sum of cash at once. But that money isn't a gift from the IRS -- it's money the IRS took away from you and is now giving back.
How to get more of your money upfront
If you commonly get a large tax refund each year, one way to score higher paychecks during the year is to change your tax withholding. This is something you should be allowed to do multiple times a year if you want to. Just talk to your payroll department at work and they will give you a form to fill out.
Now you may be thinking, "If my paychecks increase, will I risk owing the IRS money?" That's a possibility, so a good bet is to take the extra money that starts coming in and put it in your high-yield savings account. That way, the money will be there for you if you need it. But you'll also have a means of paying the IRS if you owe some money when you file your taxes.
So if, for example, adjusting your withholding boosts your monthly paycheck by $100, you'd stick that $100 each month in your savings account. If you end up owing the IRS, say, $400, you'd have money to tap, but you'd also get to earn interest on that cash instead of effectively loaning it to the IRS interest-free.
All told, tax refunds are not the awesome thing so many people think they are. While the majority of people who file a tax return end up getting money back from the IRS, a lot of people would no doubt benefit from collecting more of their money upfront during the year. And if you feel the same way, it may be time to make some changes to your withholding.
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