Many of you either celebrating the fact that you are expecting to get a refund or dreading the fact that you owe taxes. In truth, significant amounts owed or significant refunds are not the goals. The goal should be to be as close to break-even as possible. Significant refunds means that the government was holding onto your money for longer then needed. Significant amounts owed can result in penalties.

Each paycheck, money is being withheld for taxes. This is a guessing game. Your employer doesn’t know your individual tax situation. They don’t know about your investment income, mortgage, spouses tax situation or many other factors that can impact your tax status. Your employer withholds what they (or IRS tables) think is accurate given the limited information you filled out on your withholdings. The money that is withheld, could be too much or too little. It is only during tax time, that you calculate what your taxes should have been given your level of income and compare that with what was withheld each paycheck to determine if you owe more or are getting refunded.

The Problem with Refunds

Many strive to receive refunds each April, but the truth is that the government held onto your money for longer then necessary and didn’t pay you interest for holding that money. Refunds mean that you withheld too much in taxes during each paycheck or that you made too large of an estimated tax payment. It is money that could have been in your pocket earlier. A $25,000 refund means that if you had that money in your pocket a year ago and put it in a High Yield Savings Account earning 4%, you could be missing out on $1,000 of interest.

The Problem with Owing

The problem with owing too much in taxes is that it can lead to penalties. Taxes are owed when income is received. That is why employers withhold taxes each paycheck. That is why if you have a small business, you may be required to pay quarterly estimated taxes. If you owe significant amounts, the government essentially penalizes you for not giving them money earlier. Notice how when you get a refund, the government doesn’t give you interest payments. Here, if you owe money the government is absolutely going to charge you some sort of interest for not paying your fair share on time. Owing significant amounts can lead to penalties and can force you to pay estimated tax payments for the following tax year.

Small Refunds or Small Amounts Owed

If you owe a small amount of money or are receiving a small refund, no harm, no foul. Although the goal is to breakeven and not receive a refund or owe any money, the reality is that this task is pretty much impossible. There are so many variables that go into your income, most of which are reported on tax documents you receive in January and February. Pinpointing exactly how much you owe and paying the exact right amount is pretty much impossible due to so many moving parts with your tax return. The goal is to get as close to zero as possible, but in reality small amounts of refunds or owing is absolutely fine.

Summary

If you owed a significant amount or are getting a large refund, speak with your accountant to see what the culprit was and how this can be avoided in the future. They may recommend paying quarterly estimated taxes or increasing the number of withholdings you have at work. If you are receiving a significant refund, try and use this money for good! This is money that was mistakenly taken from your income that you earned during the year and given as an extra payment to the government. Refunds are not a bonus. Use this money to add to savings!