Why Big Tax Returns Are Bad (For You)
Some Americans love their tax return. It's a nice dopamine hit to see their bank account gain some weight without having to do much additional work--or so it seems.
Some Americans may not know how to influence the amount of money they owe or are owed when tax season rolls around.
Some Americans just hope for the best and try to avoid an IRS audit, which is understandable.
I can say all of this because I was one of those Americans for many years. And I got to know some of those other Americans. We talked; we laughed; and we tentatively planned our next vacation around March or April, depending on how big our returns would be, of course.
But I was wrong. We all were. Getting a big tax return is not great, and I'll explain why.
Big Tax Return = Interest-free Loan to US Government
For example, if you receive a $5,000 tax return, that means the IRS kept $5,000 that belonged to you that you were not able to use or access for an entire year. When they give you your money back, they will pay you exactly what they owe you---$5,000. No interest. No tip. Not even a thank you card.
But wait, what if you had that $5,000 throughout the year?
You could have...
1) Deposited the money into a Certificate of Deposit (CD), which are currently (2024) paying around 4-5% depending on some variables.
2)Invested the money into stocks, bonds, exchange-traded funds (ETFs), etc.
3)Deposited the money into a high-yielding savings account (e.g. SoFi).
4) Used the money (that would have gone into your bank account via your paycheck) to pay down high-interest debt, such as credit cards, personal loans, etc.
Pay close attention to the fact that buying more stuff and eating out more often is not on the list. I'm not against those things, but the whole approach depends on you making wise choices with the money that you have at your disposal.
I love my country. I mean that. The United States of America is my home. But given the situation in which I'm already supporting the government financially (you'll cringe if you calculate what percentage of your life you work to fund the federal government), I don't look for opportunities to provide them with additional financial benefits at my expense.
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| Image generated by ChatGPT on 12 Sep 2024 |
Perhaps you can relate to what this AI-generated guy is going through. He's not smiling, and most of us aren't when it comes to ensuring we've paid Uncle Sam. But the trick to winning with your taxes doesn't usually start at the time of tax filing, but rather at the time of tax withholding.
How Do I Control the Amount of My Tax Return?
Before I go any further, let me clarify that I have always worked for a company and have not been self-employed; so, this is not for entrepreneurs. This is for employees.
NOTE: When a person begins working for a company, they will be asked to complete a W-4 form, which, according to the IRS, exists "so that your employer can withhold the correct federal income tax from your pay."
When you complete your W-4, the simplest way to reduce the amount of federal income tax withholding is to claim as many dependents and credits as you truthfully and legally can claim. Tax fraud is a big deal, so consult with an accountant or finance representative at your company if you find the instructions confusing or difficult.
The IRS has also provided a tool to help you complete your W-4.
If you complete this form accurately, it will put you in a good position to accurately pay the amount of tax that you owe based on your situation--not much more and not much less. The word "much" should be defined though.
Currently (2024), the IRS will charge an underpayment penalty if you do not pay at least 90% of the tax you owe; so, don't venture too far from what is recommended for your situation.
Ideally, you will pay somewhere between 90-100% of the tax that you owe. In this case, you will owe the IRS a small (relative to your income) amount of money at tax season, but you can trust that this is beneficial to you in the long run as you gain more control over the money you earned.
Outro
A few closing notes:
1) Getting a (small) tax refund is not a problem. If you end up paying 104% of what you owe, for instance, don't feel bad. But I would suggest that you review your W-4 form(s) to figure out why you overpaid.
2) (AI-generated) You can update your W-4 tax form as often as you want throughout the year. There is no limit on how many times you can submit a new W-4 to your employer. Common reasons to update your W-4 include:
- Life changes: Marriage, divorce, the birth of a child, or changes in your filing status.
- Income changes: Starting a second job, significant raises, or receiving freelance income.
- Tax adjustments: If you find you're consistently owing taxes or receiving large refunds, adjusting your W-4 can help ensure your tax withholding better matches your actual tax liability.
3) If you enjoyed this article, please share it with someone you know.
