As we navigate the labyrinth of tax laws and regulations, it’s easy to fall prey to misconceptions. One such myth that circulates widely, especially during tax filing season, is the celebration of tax refunds. But let’s pause for a moment and ask ourselves: What exactly is a tax refund?
A tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from their paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. In essence, overpaying taxes can be viewed as an interest-free loan to the government.
On the flip side, approximately one-fifth of taxpayers underwithhold. This can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s.
Many of us look forward to receiving a refund when it comes time to file our taxes. A few hundred—or even a few thousand—dollars could pay down credit cards, pay off a bill, cushion your savings, or even fund some pampering or a shopping spree. But here’s the catch: A tax refund is not ‘extra money.’
If you receive a refund, it’s because you over-withheld and gave the government an interest-free loan for the year. If your withholding was accurate and you had that money instead, you could have made money with it by, say, putting it in a savings account or investing in the stock market.
Getting a refund one year and owing the next does not represent your tax burden or how much you paid in taxes. To truly understand how much total income tax was paid, you can look at your Form 1040 to compare how much of your earnings went to taxes versus your total earnings.
So, before you celebrate a large refund or blame tax policy if you owe, remember that it’s most likely a result of your withholding. Ready to rethink your refund? You can use the IRS Tax Withholding Estimator tool and update your Form W-4 with your employer for more accurate withholding.
Don’t be fooled by tax myths and misconceptions this tax filing season. Stay informed, stay updated, and remember, knowledge is power when it comes to taxes.