You have collected a large amount of papers and documents. I calculated it and checked it twice. You submitted your tax return early! And your reward is a generous refund, deposited directly into your bank account from Uncle Sam.
There is a bitter truth here. Americans who received large tax refunds would be better off receiving a much smaller check from the IRS, experts say.
“Everyone wants a tax refund, myself included,” Janet Holtzblatt, a senior fellow at the Tax Policy Center, told Yahoo Finance. “I know better though.”
More than three in five taxpayers received a tax refund during the 2023 filing season, with the average amount rising to nearly $3,200, according to IRS filing statistics. The average refund amount has steadily increased over the past decade, peaking at $3,300 in 2021 thanks to pandemic-related additional credits.
While everyone celebrates and welcomes large tax refunds, which can amount to half a month's salary, experts say that large checks from the IRS are too expensive, especially in today's era of worsening household debt. It warns that it could mean you are not putting your money in the right places.
Despite the “culture” of expecting large refunds at tax time, Holtzblatt said, “taxpayers are actually trying to get their withholdings correct and then putting that money in a bank account and earning interest.” It is better to do so.”
read more: Full coverage: 2024 taxes — everything you need to file your taxes on time
Credit card debt exceeds tax refund
If the total amount of tax paid throughout the year through withholding exceeds the amount owed, you can receive a refund. This money is not a gift from the IRS. It was always yours.
“If a taxpayer has received a large tax refund in the past few years, this indicates they are withholding too much from their paychecks,” says San Francisco-based CPA and MBT, Business Tax Michelle Hsu, a master's degree professor, told Yahoo. finance. “They are essentially giving the government an interest-free loan and putting less money in their own pockets.”
This is especially true as consumers struggle with the highest borrowing rates and debt balances in decades.
Bankrate reported that the average annual interest rate on variable credit cards reached 20.75% in February, the highest level in 38 years. According to the New York Fed, credit card debt in the U.S. will reach $1.13 trillion by the end of 2023, with the average credit card debt per cardholder reaching $6,864.
read more: Credit card interest rates and fees soar to $130 billion – but you don't have to pay them
“A better use of their money would be to reduce withholding taxes to pay down consumer debt or put money into savings products to earn interest income,” Su said.
Tips for updating your withholding tax
Many taxpayers don't know that withholding can be changed at any time. Payroll withholding can be increased or decreased by resubmitting W-4 forms (employee tax withholding certificates) to employers throughout the year, but experts suggest the sooner the better.
“The best time would be early this year, but if that happens.” [taxpayers] “Later in the year, you'll be able to make more adjustments to make up for that difference, because life changes over the course of a year,” Holtzblatt said.
You can download this form from the IRS website or request it from your employer's human resources department. Once you're ready to fill out your W-4, Sue said the rest of the process is quick and easy, covering issues such as filing status, number of dependents, and income. Once completed, your changes will be reflected in your next paycheck.
read more: How bonuses are taxed (and why it matters)
Beware of underpayment penalties
Experts say be careful when changing your tax withholdings if you're going through a major life change, such as marriage, divorce, the birth of a child or the death of a spouse.
Your filing status and tax bracket often change based on life events, and the last thing you want is to face an underpayment penalty from the IRS. For example, newly single and divorced people often move into higher tax brackets as single taxpayers than as spouses filing jointly, so if you don't update your withholdings, you'll end up paying more by the end of the year. You may end up paying a lot of tax.
If you don't make enough payments in a year, the IRS may think the government is lending you money, “and you have to pay interest,” Holtzblatt said.
The IRS imposes penalties on individuals who pay late or insufficient income taxes for the year. As a general rule, a taxpayer must pay 90% of this year's tax liability or 100% of last year's tax liability (110% if the taxpayer has an AGI of more than $150,000). If you are unsure of your tax liability, you will need to withhold $100. % of the amount you borrowed in the previous filing season to avoid potential penalties.
“While it's better not to get a refund, you also don't want to find yourself in a situation where you don't have the funds to pay your unpaid taxes and face penalties with interest,” Holtzblatt said.
Rebecca Chen is a reporter for Yahoo Finance and previously worked as an investment tax certified public accountant (CPA).
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