Is it good to have a large tax return?

Every changing of the calendar to a new year brings the end to the personal fiscal year, and introduces one of the least exciting, and often most dreaded times of the year: tax season. Even in 1789, Benjamin Franklin was well aware that “…in this world, nothing can be said to be certain, except death and taxes.” The tax man always comes around, and you do have to pay him what you owe. But you do have some control over what you pay him and when.

While tax season may not be smiled upon by most, a tax return is certain to make most grin from ear to ear, especially if the refund is a large one. But is a large tax refund really something to be excited about? Let’s take a closer look.

The rate at which taxes are withheld from your paycheck is calculated using the number of allowances you claim on your W-4 form. This form is filled out for the first time when you begin working for a new employer. But you are usually able to change or re-submit your W-4 if you need to make adjustments. Let’s take a personal example.

For 2017, I claimed two (2) allowances on my W-4 form with my employer. I had a higher amount of taxes withheld for that year since I chose a lower number of allowances (fewer allowances = more taxes paid upfront), and because of that, we got back a pretty big chunk of change in the form of state and federal tax refunds. Here is the issue with a big payout, however.

When you are paying more than you owe in taxes, and you get a big refund, you are overpaying. Basically, you are giving an interest-free loan to your state and/or federal government. When you get a tax refund, they don’t pay you any interest on the money they’ve essentially borrowed from you. This is a bad investment for your money! An adjustment needs to be made here.

If you do get a tax refund that is relatively large, you may want to revisit your W-4 allowances. After we got our rather sizeable tax refund in 2017, I resubmitted a W-4 to my company’s accountant, upping my allowances to five (5). Doing so lowered the amount of taxes that were withheld, or set aside for taxes, each paycheck. Doing this is going to result in a much smaller tax refund, which may seem like a bad thing at first glance. But let’s remember, if we are paying less in taxes on each paycheck throughout the year, then that is more money in your pocket with each paycheck. If you are getting out of debt, this extra could be applied using your handy dandy zero-balance budget.

In order to be tax efficient, you will want to pay attention to your tax refund this year. If it is a decent percentage of your take-home pay, you will likely want to make an adjustment. Back to our example, our tax refund in 2017 was around 6-7% of our gross take-home pay. This was WAY too large an amount. This year, we are looking at our refund being closer to 1-1.5% of our gross income instead. There is a balance to be struck here, as you don’t want to OWE a lot of extra taxes when tax time rolls around, so be smart. I used to do our taxes, but since marrying into a wonderful family full of talented individuals, I now have an uncle-in-law who is a CPA and is WAY better at this tax stuff than I could ever be.

My last point I would like to make ties into that. A good CPA (accountant) is worth their weight in gold. They will always be able to maximize your refund and find tax breaks for your situation that you likely would not be aware of if you just used TurboTax or some other tax software. Unless you are an accountant yourself, handing over the task of taxes to a true professional is the right move. Any cost associated with having them handle your tax filing will not only pay for itself, but it will also often give you back more than you pay them for filing your taxes in the first place. An excellent investment indeed!

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