Each tax season, pundits speak on the evils of a large income tax refund -- and those conversations typically start right about now. The reasons are the same, year over year: The government has your money for free because they don't pay interest while they hold your money, there are better uses of money during the year, it is a sign of financial immaturity to not maximize the money you have all year, you could invest the money and make more, etc.
I have heard them all over my 25 years in the tax business and have had my share of discussions and arguments on the topic. But I have to say, after all of these years, I still disagree. So to kick off tax season here are my top reasons why a big income tax refund is a good thing.
More than 75 percent of all individual taxpayers get refunds year after year. It has been this way for decades. Can the taxpayers and their advisers all be wrong every year? High-income taxpayers and low-income taxpayers all get these refunds. If so many taxpayers from all walks of life are getting a refund, how can it be so bad? It is unlikely that 75 percent of all taxpayers are all making bad financial decisions every year.
Since interest rates on saving accounts average about 1 percent per year and have done so for many years now, you really are not missing out on "extra" money from the earnings. If you divide your refund by the 12 months of the year, let's call it $3,000, that gives you $250 a month. If you put $250 a month in a savings account throughout the year, you would earn about $15 total for the year. You could earn a bit more if had a rocking stock fund or the like, however that is speculative at best. So while saving money is a critical best financial practice, the act of doing it every paycheck or once a year is not so important as finding a way that works for you.
Saving money in today's difficult economy is hard. Many Americans find it hard to save money each week or each paycheck. I certainly do. Many taxpayers use the income tax withholding system as their way of investing in forced savings each paycheck. Come tax time, their refund is used to pay off bills, go on a family vacation, or taking care of major expenses like buying new tires or glasses, or replacing broken appliances. If you are fortunate enough to have put aside enough income tax dollars through withholding or estimated payments so that you get a refund at end of year, congratulate yourself and be commended, you are in good company with many other taxpayers -- well over 100 million other taxpayers last year.
A big refund for some taxpayers is one example of our government assistance programs getting money to those who need it. Between 40 percent and 50 percent of households paid no federal income taxes in the last four years, and in 2013 approximately 43 percent of households paid no federal income taxes due to low income or income from nontaxable sources such as only Social Security income or government assistance. The Earned Income Tax Credit and Child Tax Credit are available to individuals and families who are working and have a low income and the credit most often creates a big tax refund. These taxpayers are unable to keep this money throughout the year since they don't have it until they file.
One alternative to a big tax refund is attempting the difficult proposition of landing right on zero, where you get nothing and owe nothing. The only other option is to owe taxes. Of the three alternatives: owing taxes, landing right on zero or near it, or getting a big refund, you figure out which one is best. Some taxpayers just want to be safe and avoid owing taxes and the risk of paying penalties for underpayment or late payment. The refund option is safer.
Some taxpayers want to eliminate ANY risk of owing a big check or any amount at tax time. The tax code changes from year to year leaving, so some taxpayers continue high withholding so they can be certain they don't owe come tax season. And, getting money back is certainly more palatable than owing. I suspect there will be a high income taxpayer or two this year from all of the tax law changes that may have to pay instead of getting their refund. They will be envious of those getting a refund.
You earned the money. It is your money. Get and enjoy the money.
- The average federal income tax refund over the last several years is almost $3,000. In my opinion, getting a $3,000 check is never a bad thing.
For many taxpayers, the income tax return and corresponding income tax refund is the largest single financial transaction of the year -- both in size and complexity. It deserves focus and attention, both during the tax return preparation and afterwards managing the tax refund responsibly. Paying down debt, putting a portion into permanent and emergency savings, and enjoying yourself is a well-deserved and earned outcome of the hard work you do all year. If you are to get a refund, enjoy it but use it wisely once you get it. Save the guilt for the financial pundits.