Hello again!
It is once again tax season. Americans are gathering their documents and submitting them to their tax professionals to file their tax returns for 2022. Those that prepare your own taxes, you are brave souls and I applaud your courage. For this post, I am not going to go into the details about deductions, taxable income versus non-taxable income, capital gains, etc. for two reasons: 1) I am not a professional tax preparer, so I do not know tax laws in detail; and 2) how your income, expenses, credits, and deductions interact with each other to determine the amount of taxes you owe for the year can be a mind-numbing occurrence for most people. However, because I am a financial coach, I want to give a little perspective for those of you who get excited with the thought of receiving a big refund.
First, let me define the tax liability. It is the amount you owe for the year based on your gross income, deductions, expenses, credits, etc. When taxes are withheld from your pay during the year, they are deposited to the IRS on your behalf. The deposits are reconciled with your tax liability through your tax return. If the amount of taxes that were withheld is higher than your tax liability, that results in a refund. The equation is simple:
Tax liability – deposits (taxes paid through the year) = Amount owed OR amount of refund
Let’s put a few easy numbers to this equation. If your tax liability equals $10,000 and you had $15,000 withheld through the year, your refund is $5,000 ($10,000 – $15,000 = -$5,000). On the other hand, if your tax liability is $10,000 and you had $8,000 withheld through the year, you owe $2,000 ($10,000 – $8,000 = $2,000). According to Bankrate.com, the average tax refund in 2022 (filings for 2021) was a little more than $3,000. I am sure almost all of these taxpayers were thrilled with this result when they were given the news by their tax professional.
I know the thought of receiving a big lump sum via a refund is traditionally thought of as a success by those who receive them. But, giving the government substantially more through the year is not a benefit to yourself or your personal finances.
First disadvantage is the refund matches dollar for dollar to the amount you overpaid. There is no calculation for interest or inflation. Here is the first real truth about that $3,000 refund that many may again receive this year for tax year 2022. You paid the government $3,000 more in 2022 and the IRS is sending back $3,000 in 2023. In essence, you loaned Uncle Sam $3,000 and he is repaying it all at once a year later. Considering that current inflation is running around 6% higher than last year, did you really receive $3,000 back? With the current inflation, you are really getting $2,820 because the $180 dollar difference is the inflation that devalued your money ($3,000 x 6%). Would you deposit $3,000 in a bank account only to have access to $2,820 the next year. No, I don’t think you would, so why do so many deposit their money with the IRS? Just a thought.
You also missed the opportunity you had through the previous year to use those funds to your financial advantage. This is the second real truth about refunds. Maybe you are struggling with credit card debt. Maybe you are planning a family vacation. Maybe you didn’t fund your retirement account. These are just a few of the items for which that tax return could have been used to your benefit throughout the previous year. Especially if you are struggling with debt. The average credit card balance is more than $5,000. Using your budget and that extra cash that is not given to the government, a substantial hit to the card balance would by far be more beneficial and would save a lot of money during the year, especially since the typical interest rate on a credit card is more than 20%.
The ideal result for your tax filing should be $0. Although this is practically impossible, the thought of you using your hard earned money for your benefit is a more comfortable feeling for me as a financial coach. If you are within $300 to $400 one way or the other after your tax return is complete, you have done well. Even if you owe a small amount, this means you were able to keep most of your extra funds for your benefit and your financial future. Please consult with your tax professional. He or she will be able to reasonably estimate your tax liability for 2023, so you can adjust your withholdings accordingly and better your personal finances.
If you are interested in a free financial coaching consultation, please visit www.ifcmoneycoach.com, give me a call at (619) 551-4625, or email me at [email protected].
Thank you for reading!
