Why a Big Tax Refund Shouldn’t Excite You
Once again, it’s the most dreaded season. Around this time of the year, I often write something about taxes. What can you say? It’s difficult to forget about the tax system after hours spent working on my taxes.
Unfortunately, our tax system is also often misunderstood. It’s not difficult to find people online celebrating big refunds and mourning small ones. While this is understandable, it is not right. A big refund isn’t a good thing. Understanding the concept of withholding is key to understanding why.
You can withhold your money
The IRS is able to issue tax refunds. The IRS sometimes collects more from you than you owe. In other words, you receive a refund. This is not a reason why our system should allow it.
This system is called withholding. This system allows the government to withhold a portion of your salary (to pay estimated taxes), and release it back to you if there is too much.
The US government did not collect taxes from employees’ paychecks before 1943. Instead, taxpayers got their entire paycheck and were able put some away at year’s end to pay taxes.
The withholding system was created during World War II to finance war efforts. Instead of waiting for the end, the government could take money straight away and have more cash to spend on wartime.
It is interesting to note that Milton Friedman, an economist who has been a champion for small government policies, was a major developer of the withholding program. Friedman did not apologize for the system. Express your regret It continued to peacetime.
This is where you might be asking why it matters if the government withholds the money. It doesn’t matter if $1,000 of taxes is owed to the government by someone born before 1943. They will still need that money to pay taxes. It doesn’t matter if the taxpayer spends it or not, because who cares?
The first is that the government can withhold too many dollars from someone’s paycheck. If someone is in dire need of extra withheld money, and the government keeps it until April, then that’s a problem.
This is why you shouldn’t get a large refund. A large refund is simply a sign that the government has been holding onto a lot of your money for a year, and you don’t have any access to it. But this is only one example of the problem with government withholding.
An interest-free loan
You should also be concerned about a large refund. It can literally mean that you are poorer than you would be if you received a smaller refund. Why?
Remember, not having money doesn’t mean you can’t use it. Let me give you two options. You can either have $100 today, or $100 per year. Which is better? It’s better to have money now than later, even if inflation is not an issue. You can either use the money immediately or keep it for up to a year. This is a better choice than any other.
To quote an article I wrote, “the time value of money” is the fact that money today is more valuable than money tomorrow. A sum of money today will be worth more than the same amount of money later in time. This is evident when you consider borrowing money.
If you borrow money for yourself or your business, you agree to pay back the loan amount in return for a lump sum today. Get larger Sum of money to be paid in the future (the loan payment). plus interest). Individuals who pay interest agree that $100 today is more valuable than $100 in the future.
Now that we know money today is more valuable than money tomorrow, it is easy to see why large refunds are so problematic. A $3,000 refund is equivalent to $3,000 in government funds. This money was yours for the year and the government was able earn interest while you weren’t.
You could earn $90 if your money was kept and placed in a 12-month CD (Certificate Of Deposit), which earned 3% annually interest. You get nothing if you withhold that money.
Don’t be happy if you get a large refund. Reflection is better. Employers require workers to fill out a form that determines how much money is withheld each year. This is the norm in employment. This is the W-4 form. You may have filled out your W-4 in a way that is too restrictive.
But beware the Double Standard of Government
An intelligent person who has read this article might be tempted to try to reduce the amount of money that is withheld. A negative refund is a way to earn more interest if you have a large refund that means you paid the government an interest-free mortgage. Unfortunately, no.
Although you may be able to earn more interest and hold more money by paying in less at the end, the government will penalize you for doing this too often.
There are different rules depending on your situation. However, if you fail to pay enough withholding taxes during the year, you will be penalized by the government.
Why would you be penalized by the government for paying what you owe if you owe it now rather than when it was due? They also know that withholding more money can earn you more interest. To discourage people from minimizing their withholding, they penalize anyone who does. “underpays.”
Ironically, the government never pays out a bonus to people when they overpay throughout the year—regardless of the amount. This amounts to a type of “heads I win, tails you lose” Double standard, where taxpayers are responsible for determining how much they must pay in. The government will penalize you if you underpay. If you overpay, that’s also your fault and the government will take the interest-free loan—thank you very much.
If you get a $0 refund this tax year, it is a good thing. This means that you can keep more of your money and Uncle Sam won’t have to borrow interest-free.
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