Getting a tax refund may seem great, but tax pros say it’s also a sign two things could be happening: You may not be doing enough tax planning, and you might be needlessly shrinking your paycheck.
Why tax refunds aren’t always wonderful
Tax refunds often happen when people have too much tax withheld from their paychecks over the course of the year. If, for example, your employer withholds $400 from your pay twice a month, you’ll have paid $9,600 in taxes by the end year. When you prepare your tax return in April and it turns out your tax liability for the year was actually only $4,000, you’re probably going to get a $5,600 tax refund.
That sounds great — until you think about what life might’ve been like if you’d had that $5,600 during the year. That’s about $467 a month you could’ve had to buy groceries or get the car fixed, pay down a loan or credit card balance faster, or invest for the future.
“It’s your money, and you should get it all year long,” says John Walters, a certified tax coach at LeWalt Consulting Groupe in St. Petersburg, Florida. He notes that most people could do more with their money than “giving a free loan to the government for the year.”
How to keep more of your money
There are two ways to make sure you’re not paying Uncle Sam more upfront than you need to be.
1. Estimate your tax liability
The first thing to do is come up with a reasonable approximation of what your tax bill will be for the year, Walters says. It’s especially important to do for 2018, because tax rules and tax brackets changed significantly this year.
Estimating your tax liability might mean talking to a tax advisor, looking through your previous tax returns and thinking about whether you’re making any life changes that could affect your tax situation, such as buying or selling a house, having a baby, starting a business, or getting married or divorced, says Harvey Bezozi, a certified public accountant and certified financial planner at The Tax Wizard in Boca Raton, Florida. Many name-brand tax software packages have modules that will help you forecast your tax liability for the year, too.
2. Tweak your W-4
If you got a big refund, you may be having too much tax withheld from your paycheck. Instead, give yourself an immediate pay raise by reducing your withholdings to a level that more closely matches your estimated tax liability for the year.
You can make the change by filling out a new Form W-4 and giving it to your employer. A W-4 tells your employer how much tax to withhold from each paycheck, and your employer then remits the calculated amount to the IRS on your behalf. The IRS has a withholding calculator that can help, Bezozi says.
You probably filled out a W-4 out when you started your job, but you can change your W-4 at any time, he says.
“Ideally you want to break even at the end of the year. You don’t want a refund, and you don’t want to owe,” Bezozi says. “I would equate it to managing your budget properly. You’re managing your W-4 budget.”