Your tax refund isn’t a gift
Uncle Sam’s largesse is your overpayment.
If you’re one of the roughly 96 million Americans expecting a tax refund in early 2020, there’s a good chance you don’t understand how they work.
About half of taxpayers realize that refunds reflect money they paid to Uncle Sam, according to a survey of more than 1,000 taxpayers from Credit Karma. Nearly all remaining respondents say refunds are payments from the government, rather than reimbursements for overpayment.
Those findings highlight a lack of knowledge and a missed opportunity to shape your tax outcome, says Christina Taylor, senior manager of tax operations at Credit Karma. If you don’t understand that refunds stem from tax overpayment, you might not take steps to address that.
“For most people, a refund means they are giving the government an interest-free loan,” Taylor says.
More than half of taxpayers said they’d rather receive a tax refund than get more money in their paychecks. It’s easy to see why: The average refund for the 2018 tax year was $2,725. Credit Karma found that tax refunds represent the biggest “paycheck” of the year for 44% of those polled.
Tax refunds can offer a chance to catch up on bills, take a vacation or pay down debt. That $2,725 spread across 24 bimonthly paychecks is about $113 in additional income per pay stub, which may not sound as enticing as a bigger lump sum.
Enforced savings?
Some financial advocates view tax refunds as an enforced savings mechanism. By overpaying the IRS, taxpayers effectively set aside money they can put to work when they receive their refund. There’s evidence that Americans tap their refunds responsibly: Credit Karma found 51% of respondents plan to use their refunds to build their emergency savings.
However, relying on the IRS for your emergency fund isn’t as beneficial as it sounds. The IRS doesn’t pay interest. If you had instead socked away that money into a high-interest savings account you’d come out further ahead over the course of a year. And unlike a bank account, you can’t withdraw money from the IRS in an emergency.
When should you adjust?
Most consumers can tweak their expected refunds by changing their withholding, which is done by revising your W-4 form with your employer.
Taxpayers can check their withholding through the IRS’ tax withholding estimator. Checking in early January could help prepare you for the 2020 tax year, the agency says.