Why Large Federal Tax Refunds Are Bad for You

Who doesn’t love “free money”? Many of my clients wait anxiously every year, hoping to receive large refund checks from the IRS. What to do with that annual “gift” from the IRS? Should you buy a new car? Take the family on vacation? Finally get that new iPhone? The possibilities are endless. But does receiving large tax refund checks every year really make sense? Let’s take a deeper dive.

Someone once told me that if they didn’t receive a large tax refund, it meant that they hadn’t done their taxes correctly. While fighting the urge to cringe and replacing my inner look of horror with an outwardly warm smile, I explained that while tax refund checks are nice to receive, they are not an indication of “how right” or “how wrong” you prepared your tax return. Instead, they are an indication of how much or how little of your hard earned money you chose to let the Federal Government borrow during the year.

Receiving a giant tax refund isn't cause for When you receive a tax refund, the government is simply returning the money you’ve overpaid the previous tax year. In a sense, you’ve offered the government a 0% loan with which they can do whatever they want. You wouldn’t loan your hard earned money to a complete stranger, would you? So,why in the world would you loan it to the Federal Government?

Fortunately, the solution to this problem (you didn’t you know you had) is simple. It only takes adjusting your W4 withholdings. The W4 is the form is not an IRS document. It is the form you fill out and give to your employer that decides how much money is taken out of each paycheck to pay your Federal Income Taxes. There is an equivalent W4 form on the state side, if you live in a state that requires you to pay state income taxes. Work with your tax professional to determine the appropriate amounts that should come out of each paycheck for Federal Income Taxes. In a perfect world, the amount you owe and the amounts taken out of your paychecks will balance, and you’ll owe $0 come tax day.

Before the Covid-19 pandemic, the average tax refund was upwards of $3,000. Think about all the different things you could do with an extra $3,000 in your pocket. You could pay off credit card and other debts. You could place that money into a savings or investment account. $3,000 is more than enough money to cover the newest iPhone. While I don’t recommend splurging, the point is that you shouldn’t allow the government to have its way with your money. Your money is yours. Keep it in your possession. Let your money work for you, not the Federal Government.