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Why You May Not Want a Big Tax Refund

Written by prositesfinancialMay 13 • 2 minute read

women discussing taxes

Once done with the hectic process of filing taxes, most taxpayers eagerly await refund checks from the IRS. Although it feels like bonus earnings that you can put to other uses, that’s not the case. The main reason for tax refunds is the cautious overpayment you might make due to fear of tax penalties.

Why a Big Tax Refund Isn’t Always a Good Thing

If you receive a large refund, it means you gave more money to the government than was necessary. These are funds you would have put to better use. The majority of Americans are servicing student loans, credit cards, mortgages, and other debts. Only a few can manage at least $1000 in emergency savings.

Your debt management would improve if you could receive the extra cash regularly instead of the IRS sitting on it for months. A sizable tax refund is also an indicator of inaccurate bookkeeping and accounting practices. By reviewing your refund history, you can identify the reasons for perennially overpaying and adjust your W-2 form accordingly.

The Tax Cuts and Jobs Act (TCJA) slightly reduced the average refund and implemented changes to the IRS’s withholding tables.

Why You Should Stop Focusing On Big Tax Refunds

Overpaying your tax means you’ll fail to maximize other prospects such as:

  • Retirement funds: Higher traditional or Roth IRA contributions guarantee a more comfortable lifestyle after retirement.
  • College fund: A 529 plan helps you manage higher education costs.
  • Stock market: This investment option offers decent long-term returns compared to standard savings accounts.
  • Career boost: You can improve your career prospects by acquiring an in-demand skill such as coding.
  • Home improvement: Although some green home improvements have high initial costs, they result in significant overall savings.

The IRS offers a tax withholding estimator to help you calculate your liability. It ensures you pay an adequate amount without handing over too much to the government.

How to Adjust Tax Withholding

Dividing your latest tax refund by 12 gives you an understanding of how much you overpaid per month. One way of reducing this amount is by filing Form W-4 with your employer. This process helps you accurately identify the exemptions that you can claim. Examples are mortgage interest and expenses on investments. Major life events such as marriage, divorce, and more dependents also affect your refund dynamics. While most people don’t bother with these details, it makes sense to analyze any changes in your life for tax purposes.

Tax planning strategies are also vital for ensuring your refunds are as close to zero as possible. The ever-changing tax code creates such opportunities every year. For employees, withholding strategies include bunching deductions and making the highest contributions to retirement funds. Insurance and retirement plans are also valuable tools if you’re self-employed. 

Always Talk to a Professional

Expert financial advice doesn’t just reduce your withholding tax. It also helps you make the most of tax refunds. Skilled CPAs, enrolled agents, and tax attorneys are the most qualified professionals in that regard. They’ll offer you crucial tips about accurate accounting, tax preparation, and debt settlement.

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