Over the past couple of weeks, I've had several people I know mention to me that they were surprised that their federal income tax refunds were considerably smaller than they had anticipated. I get the feeling that some of them, probably like many Americans, count on getting a nice chunk of change back on their tax returns.
Personally, I believe getting a big refund back is a mistake. It means you've overpaid your taxes throughout the year, essentially giving the IRS an interest-free loan on your money. With the power of compounding interest, it makes more sense to take the money during the year in your paycheck -- even if you put it in a low-interest money market account, you're ahead.
But I realize that's not for everyone. Some people use their overpayment of taxes as a forced savings tool. They pay extra taxes throughout the year because they'd spend the money otherwise. If people lack the discipline to invest or save the money, or pay down debt throughout the year, than this is a better strategy than, say, taking the extra money and spending it on "toys."
I am consistently amazed that the average American carries credit card debt, yet also overpays taxes in order to get a once-a-year windfall. If they'd change their witholdings to get the money in their checks, they could consistently chip away at high-interest credit card balances, and/or have more money in their pockets each month so that they could avoid buying things on credit.
But back to the original issue. People have remarked that their refunds are smaller.
One of the reasons is the Making Work Pay tax credit. Remember how a couple of years ago, we got stimulus checks in the mail? That was the government's way of trying to jump-start the economy by giving us "extra" money to spend.
Last year, the Making Work Pay credit gave Americans that extra money in their pay checks. If you're single and earning a pay check, chances are your employer's witholding tables were adjusted to pay $400 less in taxes throughout the year. A married couple would have gotten a total of $800 back in their pay checks.
Paying less tax throughout the year means getting less money back when you file your return, just as if you had adjusted your own witholding on a W-4 to get back less at the end of the year. The government simply did it for you.
This credit is also in place for 2010, so be prepared to again pay $400 less per person during the year in taxes and get back less on your refund. Your pay checks might change slightly this year, as the credit is spread over 12 months, rather than the nine months it covered last year, but the end amount should be the same.
If you're one of those people who need the IRS as a forced savings plan, you will have to adjust your W-4 witholding if you want to get a bigger refund next year. If you are more disciplined, remember that you will again have "extra" money in your pay checks throughout the year to invest, save or pay down debt.
Remember, a smaller refund isn't necessarily a bad thing.
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