By Ken Rosenbaum, CPA
Think April 18.
Imagine that you have just finished your taxes and you find out that you are going to receive a refund. What is your first reaction? Are you excited to be about to get some “free” money? Is it already burning a hole in your pocket when deciding what to buy with it? Others may view their repayment as forced savings.
There are plenty of ways to put your cashback to good use if you’re more into this camp. You can put the money in a high-yield savings account, invest it in an IRA or Roth IRA to meet your retirement income needs, or invest it in a 529 plan for your education. your children. If you have credit card debt and are paying a high interest rate, using your refund to pay it off is probably a good strategy.
A third group of people sees the refund amount and is irritated by it. Irritated? Really? This kind of feedback might seem counterintuitive – until you take a closer look at why you received a refund in the first place. Then it might not taste as good as you might initially think.
Paying Income Taxes – The Basics
By stepping back to cover some basics, you know that each pay period your company sends a portion of your income to the government for taxes – your payroll deductions. At the end of the tax year (by the following April, when you file your tax return), it’s time to equalize or calculate the exact amount of taxes you owe based on the exact amount of income you have earned (including income from other sources) minus any deductions and/or credits you are entitled to.
If the amount withheld from your paychecks is more than you should have paid, you will receive a refund. So essentially you have overpaid the government and just receive your overpayment amount. And while the government “holds” your money, it pays you no interest. It’s nice to give the government an interest-free loan. Do you still feel so happy about this refund?
If you start to feel less generous, that’s perfectly normal. The good news is that you have some control over how much your company withholds for taxes from your paycheck. There is a form called a W-4 (ask your human resources department where you can find it) that asks a few simple questions to help you decide how much to withhold. Basically, the more exemptions you claim or receive, the less money your business withholds for taxes throughout the year and the more money you’ll see on your paycheck.
Another common method for people to pay taxes throughout the year is to pay estimated quarterly taxes. Here you make payments on a quarterly schedule based on an estimate made at the beginning of the year. The good news for these taxpayers is that it can be easier to manage the amount you pay and adjust it as the year progresses.
Whichever method you use to pay your taxes, once you recognize that you’ve overpaid, the question then becomes what to do with that refund. We’ve talked about some of the choices before, but an additional – and often under-mentioned – option is to roll your refund into next year’s tax payments. It may seem like an attractive route, if not the most glamorous.
Alternative methods of paying income taxes
But before you simply answer the default “yes,” take a moment to ask yourself if you anticipate any significant changes in the next few months. Do you expect to post less revenue this year? Was last year an incredibly profitable year? Do you expect to book fewer capital gains this year? Do you foresee higher expenses this year? Are health care expenses or capital expenditures of your business deductible? Maybe you are finally ready to retire or are planning to retire fully at some point in 2022. If so, you may not have as much income this year and therefore will not have no need to pay so much on a quarterly basis.
After reassessing your personal situation in light of these and other factors, and if your refund ends up being what you expect to pay as your new first quarter estimate, it makes sense to roll it into the next payment. However, if the repayment is greater than the quarterly adjusted estimated quarterly payment, it may not make as much sense to defer it. (It boils down to why would you want to give the government a tax-free loan if you don’t have to.) In that case, consider receiving the repayment amount on top of your first quarterly payment, and then pay your taxes. throughout the rest of the year as needed.
Whether a refund is a good thing or a bad thing is not so clear. From an economic perspective, the most efficient use of your capital would be to have a $1 tax bill at the end of the year. However, for people who for one reason or another need a little help saving, receiving a refund may be more beneficial as long as it is used wisely (invested for the long term or used to repay debt at interest rates, for example). In financial planning, there are many instances where what is economically best does not entirely correspond to what is behaviorally best.
As you dig to determine what may be different this year compared to last year, you will begin to see that the withholding process begins to become less about taxes and more about experiences and personal decisions. The right answer for you lies more in the personal situations you anticipate and the financial implications of your decisions. And doesn’t that seem like a more logical way to look at your whole financial plan anyway? Reverse the process and take the approach that money is a tool you apply in pursuit of your best life.
About the Author: Ken Rosenbaum, CPA, RLP®
As a wealth advisor to Buckingham Strategic HeritageKen Rosenbaum, CPA, RLP®, helps families chart their ideal path into the future, then works with them to get there through a holistic, values-based financial life plan that incorporates investment, tax, charitable giving, wealth transfer and retirement. .
Important Disclosure: The views expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth®. This article is provided for general information and educational purposes only and is not intended to be used as specific financial, accounting, legal or tax advice. Individuals should speak with qualified professionals based on their personal circumstances. The analysis in this article may be based on information from third parties and may become obsolete or otherwise superseded without notice. Third-party information is believed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has endorsed, confirmed the accuracy, or determined the adequacy of this article. R-22-3331
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Email Jeffrey Levine, CPA/PFS, Director of Planning at Buckingham Wealth Partners at: AskTheHammer@BuckinghamGroup.com.