As the federal tax return deadline came and went, I saw a new take on the subject of tax refunds pop up everywhere. Maybe you’ve been hearing it too: “tax refunds are interest-free loans to Uncle Sam”. I don’t know about you but seeing this message makes me uneasy.
When I was growing up, tax refunds were more or less a good thing. These days, some people are sharing views that challenge what I’ve learned and experienced. Here’s why I think rebranding it as “an interest-free loan to the IRS” is a bad idea and more harmful than helpful:
- It makes us feel like we’re doing something wrong. For many of us receiving a refund check is a normal, expected part of being a W-2 employee. A lot of us, myself included, learned to even look forward to that time of year.
- It evokes a negative emotional response. All of a sudden, the wheels start turning and we’re asking ourselves “why would we do that?” “how is that fair, when my [insert] loan charges X amount of interest?” This narrative can make us feel frustrated and taken advantage of without giving us a solution or alternative to this problem we didn’t even know we had.
The bad part of this tax narrative is subtle
By putting tax refunds in this negative light, it’s easy for us to make the following connections: “tax refunds are bad” “I get a tax refund, which is bad” and therefore “I am bad at money”. This is the essence of why I believe this “interest-free loan to Uncle Sam” perspective is harmful.
The truth is:
- Receiving a tax refund closer to $0 does not automatically make someone good with money.
- Receiving a larger tax refund does not make anyone bad with money.
So, what does it mean?
After filing your taxes, it means you overpaid and now owed the amount of the overpayment.
Example: If you paid $4000 in taxes, but only owed $2500, then you’d be receiving a refund of $1500.
Editor note: There are factors that impact your tax brackets and federal taxes owed such as using itemized deductions or the standard deduction. Credits and deductions impact your actual income taxes owed and how much you may get back.
Now that we’ve seen tax refunds aren’t bad or good, here are 3 ways it can have a positive impact on your finances:
Increase your savings
It’s like extra cash. You can use your refund to save for an emergency, large purchases, or future goals.
Invest part or all of it
Investing the tax refund can allow more of your money to work for you (even better if it’s put towards retirement savings).
Pay down debt
The extra money can be used to make additional payments to your principal loan (a student loan, car loans, mortgages, etc) will help you pay off debt faster and save on interest in the long run.
A Different Take on the Income Tax Return
One of the things this new perspective fails to mention is how easily that amount of money could be spent if it were paid to us directly as part of monthly cash flow. Did you know spending an extra $13.70 per day will add up to $5,000 by the end of the year? While not everyone will receive a tax refund for that amount, imagine what could happen to a lesser amount.
According to GoBankingRates, the average tax refund issued per return ranges from $2,314 (Maine) to $3,191 (Texas). Looking at these numbers, that means you’d only have to spend an extra $6.34 to $8.75 per day to unintentionally spend what would have been refunded.
And let’s not forget that our tax refund money would be split up between all our checks for the entire year. That makes the above example even more likely to happen for the majority of us.
If you’re like me, you may prefer to receive a lump-sum direct deposit after you file your taxes. The tax code is complicated and I’m not convinced I would better manage the money across each check. For this reason, I’m not upset to be receiving a tax refund. Honestly, I’m just relieved I don’t owe any taxes after I file. Also, I have no plans to go down a tax code rabbit hole and learn how to get my withholdings exactly right. If that’s your cup of tea, more power to you.
So, are tax refunds good or bad?
My takeaway from this whole anti-refund topic is the following:
- Can you choose to see it as interest-free loans to the IRS? Sure.
- Could you also view tax refunds as a form of forced savings? Again, sure.
Ultimately, your tax refund is your hard-earned money. Throughout the year, you overpaid the IRS and it’s the excess. You get to reclaim that excess during tax time from the federal government. So in other words: it’s not a bonus, extra money, or a gift even if it may seem like it. It’s important to remember that you, in fact, earned that money. How you decide to spend that money is a personal decision. However, I would like to ask you this question: “Knowing that your tax refund is actually money you earned, will this change the way you use it?”
Editor considerations: Still have questions about taxes? There are specific details to consider regarding your filing status and tax rate. Consult with tax professionals regarding your situation. You don’t have to wait for tax season to do so.
How Do I Know if My Refund Is Too Large?
According to the IRS, the average tax refund in 2020, for the tax year 2019, was over $2,500. If the government took the correct amount from the taxpayer’s pay, the average taxpayer would take home over $100 more per paycheck.
If you want to control the size of your refund, you can change the amount of money that is taken out of your paycheck. You’ll get more money in each check if you have less tax withheld taken out. You can use the withholding calculator on the IRS website to help determine the right amount.
How to Adjust Tax Withholding
If you think you have too much or too little tax withheld from your paycheck, reach out to your employer to change your filing status and the number of dependents claimed. Changes to your withholding require completing a new Form W-4. Your employer will make the adjustments that you will see reflected in your paycheck.