Tax Returns and Guidelines

Today’s post is from Ben.  Thanks Ben!

It’s nearly April, which means we’re only a few weeks away from April 15th, the day taxes are due for most Americans. Hopefully, you’ve already filed and your refund is on the way, but in case you haven’t; better get a move on!

In either case, if you’re a normal family, you’re probably pretty happy right now, since the average American household is expected to receive a refund of $3,100 this year. The question I ask though, is this really a good thing? Of course I’m happy that you’re getting money back; we are as well. What DOES bother me, and the reason I’m driven to ask this question is, “What is best for my family?”

Let’s start by looking at this in reverse. Let’s say you’ve got $3,100. You decide that you don’t really need it at the moment, so you decide to invest it. The bank offers to loan it to others for a year; like a certificate of deposit (CD). They offer you the amazing interest rate of 0%. They are willing to take your
$3,100 for a year, and give you absolutely nothing in return. Sound like a good deal? Want to sign up?

In addition, considering that inflation will probably go up between 1-3% during that year, in actuallity, your money will be worth less when you get it back than when you started. Even better right?

Well, that is exactly what a tax refund is. You loan the government thousands of dollars for a year, and receive absolutely nothing in return. So instead of using that money to pay down credit card debt, which might save you 8-20% interest, you get 0%. Or, instead of investing your tax refund into the stock market (in a 401k or Roth IRA) every April, where it would have had a chance to grow 8-10% during that year, you get 0%.

Not only do you receive no interest, AND lose money due to inflation, but if you are lucky enough to live in a state like California, you might not even get your money back at all, and instead, the government might give you an IOU.

The far better idea is to adjust your W-4, the IRS form that sets your deductions, and determines how much of your paycheck is withheld for taxes each year, so that you receive only a few hundred dollars at the end of the year, or better yet, that you owe a few hundred. Wouldn’t you rather the government wait to get money from you, instead of you having to wait, or beg, to get it back from them? When the W-4 was first created, the deduction formula was pretty accurate, but as time has gone on and our tax code has become more and more complicated, to the point that is is now nearly 65,000 pages long, the W-4 deduction calculation isn’t very useful anymore. You should talk to your tax professional, and if you have to claim 25 dependents to not get a refund, do it. In the end, that dependent number has nothing to do with what reality is, but rather is just used to calculate your withholding.

For most people, your expenses and pay should remain pretty steady from year to year. Obvously, if you have a huge gain of income in a year, you might not have enough taken out, and inversely, if you have a large, unexpected expense, you might still be taking out too much. The point is though, that with a tax professional’s help, you should be able to estimate your tax burden for 2010, and take home an extra few hundred each month, rather than getting it all the following April.

Use that extra money each month to buy more organic foods, or pay down some debt, or take some college classes. Enrich your lives, and take control of your own destiny, instead of feeling honored, because YOUR government, gave you back YOUR own money, with no interest.