Tax Bill or Tax Refund, Which is Better?
There are two typical responses when a person finishes preparing his tax return, depending on the result. If he owes money, I hear, “Do’h! I have to pay the government more. I wish they’d use my money more efficiently.” If he is due a refund, I hear, “Woohoo! I’m going to get a big fat check from the government!”
I like to receive checks in the mail just like anyone else. But the check from the goverment I’ll receive for a tax refund is my own money. I let the government use it over the course of the past year. Now they’re repaying the money I lent with no interest. That doesn’t sound like a good deal when that money could have been invested. It’s not a good deal for the economy either, as they money could have been dumped into the market if I chose to purchase more cable modems.
Meanwhile, companies want you to receive the lump sum check from the government, and they have created contests and “deals” designed to get you to use that newfound money with them. H&R Block is urging you to double your refund just by filing your taxes with the company. Note that if you file your taxes but are due a refund from the IRS, according to their frequently asked questions, you receive the minimum winning of $1,000.
For those expecting a refund of larger than $900, Jackson Hewitt offers a MoneyNow Loan. They’ve advertised this on television every year for the past few years. Here’s a commercial that sticks out in my head: The tax advisor is sitting at his desk, talking on the phone to a customer. He mentions to the caller that he can file his taxes and have his refund today. The camera zooms out and the caller has materialized in the studio where they’re recording the commercial. It’s a very fourth-wall type of experience.
In any case, these loans are not good deals. The fees are generally outrageous. I’d like to give you the details, but Jackson Hewitt’s schedule of fees is only available if you open an account with them. About.com has the skinny on these types of loans, which exist to take advantage of lower- and lower-middle-class workers who live paycheck to paycheck.
Can we conclude that it’s better to owe the government on tax day than to receive a refund check? Well, not always. The individual who is reponsible with money would be better off owing the government at the end of the year. This person will invest the difference after each pay period in an appropriate fund so the money will grow over the short term. At the end of the year, there is money left over after writing that check.
The irresponsible person may spend this money for frivolous things or invest poorly, losing money over the short term. Perhaps that will result in the lack of cash to pay the tax bill at the end of the year. The tax goes onto the credit card, and he ends up paying interest on that balance. This guy would have done better by letting the goverment hold onto the funds, even at 0% interest.
(Mighty Bargain Hunter has a warning: don’t owe the government too much at the end of the year; you could end up owing a penalty fee for underpayment of estimated taxes. Here’s how to calculate the penalty . Good luck.)
If you file your taxes with help from a company like H&R Block or Jackson Hewitt and you end up owing money, they make it easy to pay your taxes with your credit card. Someone is always anxious to make money off of people.
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I am an accountant who has prepared Federal and State income tax returns for the past 24 years. No matter how I advise my clients, everyone has a different opinion on receiving a refund or owing taxes. Some people believe that receiving a large refund is a forced savings, even though the Federal government is in fact working with their money, whereby if they were to plan better, they could receive more money each pay period and invest this money in a conservative interest bearing instrument and yield more money by year end. On the other hand, I have clients who will owe Federal Taxes at year end, and don’t mind paying the U.S. Treasury, even if it includes paying a penalty. The penalties for underpayment of federal taxes really are not that large, and therefore, appear to be a small penalty to pay, for owing the tax. It’s like paying a cheap interest rate for borrowed money, that you now have to pay back. Someone made a suggestion above, that they had considered no Federal taxes withheld from their (employee) paycheck, then invest the amount of federal taxes that would be withheld, and then earn interest on that money. Great idea (from a financial viewpoint) however, just remember that the Federal government’s rule is for anyone with taxable income to “pay as you go”. Therefore, whether you are an employee or self employed, you should pay your estimated taxes by the due dates, as set forth by the Federal government’s guidelines and published due dates. If paid on time, I don’t know of any rules being broken, therefore you would earn “some” interest on those funds reserved for Federal taxes withheld from your paycheck. Remember, you would have to file a W-4 with your employer to claim “tax exempt” and then take personal responsibility for your personal Federal income tax liability. I must also mention, I haven’t reviewed the recent guidelines on W-4’s, and therefore you should research whether you can legally claim tax exempt without having the I.R.S. refuting this status. If you can claim tax exempt on your payroll, you really need to pay attention to the estimated tax due dates, and pay the amount on time. According to recent articles published by the I.R.S., agents are going to start paying closer attention to small businesses that are not paying estimated taxes by the due dates, and possibly enforcing underpayment penalties, since some (self-employed) taxpayers won’t make their estimated taxes when due, and wait until year end to pay any tax due.
Please contact your personal tax advisor or me at my email address if you have any more questions.
I think there’s a secondary benefit in owing the government a big fat check at the end of the year – it gets you mad. It makes you want the gov’t to account for the taxes they take from you and, hopefully, prompts you to be more proactive in the political process. A lot to ask/hope for, but I firmly believe if the gov’t didn’t withhold ANY money and made everyone pay a big check at the end of the year, we’d quickly have a more reasonable tax code/rate.
“modest refund” is really the sweet spot. I even used the IRS’s withholding calculator early last year and I am still due over $400 in a refund before factoring in all the non-cash donations we made. Speaking of which…I better file my taxes asap and get that money! LOL
I am awful at estimating my withholding. The past 2 years running now, my wife and I have owed about $6000 each year and it is killing us. They really need to simplify the tax laws to make all of this easier to figure out. I screwed myself because we moved out of one house 1/2 way through a year, lived in an apartment for a year, and then moved into our new house 1/2 way through another year. This left us without 1/2 our interest deduction for 2 years running now and left us owing a lot.
Small tax bill all the way for me! And I would’ve had just that this year if I didn’t get married in the middle of it and forget to adjust my W-4. But trying to hit the small target between 90% and 100% of your taxes can be tricky, so I won’t be too upset if I get a small refund … say, 1% of AGI.
When it comes down to it, I prefer a modest refund as well. My latest 2005 tax calculaton shows I’m due a refund for $12 (much better than my early estimation of owing $2,000). I wouldn’t say that having that $12 throughout the year instead of the refund would have benefited me in any way.
I’m with Bill — a modest refund is ok for me.
The system is a bit complicated. The penalty is for all income-earners, not just the self-employed. If you’re getting a refund, there’s nothing to worry about, but if you owe more than a certain amount and you meet some other conditions, you could owe a penalty.
This article and this article from The Motley Fool explain the nuances in good deail. The numbers are a few years old, but the information should be generally the same for the 2005 tax year. The author has updated some details for 2005.
Here is another resource.
Ok so I was reading what you had to say about owing the gov’t a penalty if you don’t have enough taxes taken out of your paycheck during the year. Can you expound on this. My husband and I were thinking about setting up his paychecks at work so that no federal taxes come out of them, and then just put the amount that would have come out of them each week in our HSBC account and let it earn interest. This year we actually got more money back from our tax return than what we paid in (because of our student loan interest and because of the child tax credit) so we will probably get a refund next year even if we have no taxes taken out. So if we set it up so no federal taxes come out of his check will we really have to pay penalities, or is that just for self employed people? Thanks
I’d prefer a modest refund ($50 – $100 or so). Using the same theory that you don’t miss items deducted directly from your paycheck such as 401(k) contributions, charitable deductions, etc., taxes work the same way psychologically for me. I don’t mind them coming out at paycheck time, but paying them in April by writing a check bugs me to no end, even though I’ve saved more than enough during the year. Once my paycheck is direct deposited, it’s my money darnit, not the government’s.
As I’ve written on my blog recently, though, my tax estimation is terrible. Too many life changes that also change tax liability. Relocating in 2005 really threw me off…the reimbursements from my employer had tax withheld significantly higher than my effective tax rate.
Thanks for the reminder! I added some information on that penalty above.
I should do a better job with my personal exemptions, since I usually get a large refund. The flip side is that you can carry too many exemptions, and not pay Uncle Sam enough throughout the year. Then you owe penalties.