3 Things Your Tax Refund Can Tell You About Your Finances (And What To Do About It)
Written by
Josephine Nesbit
Edited by
Zuri Anderson
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Your tax refund — or lack of — can tell you a lot about your finances. It may feel great to get a big tax refund, but it doesn’t mean it’s better.
“In a perfect world, we would estimate our tax liability perfectly every year, but that rarely happens — there are just too many variables,” explained Christopher Johns, founder and wealth advisor at Spark Wealth Advisors. “The closest I’ve ever seen someone get was a refund of $8; now that is spot on. For most of us, we end up in one of two situations: You owe or the government owes you.”
Here are three things your tax refund can tell you about your finances and what to do about it.
You’re Overpaying in Taxes
“If you get a large refund, you overpaid on your taxes and gave the government an interest-free loan,” explained Jay Zigmont, PhD, certified financial planner (CFP®) and founder of Childfree Wealth®.
This means your money sits with the IRS until you get your refund.
“One of the weird things about IRS is that they will charge you interest and possibly penalties on any underpayment, but they do not pay interest on overpayments,” he added.
If you get a big refund, Zigmont said you need to figure out why. For W-2 employees, it could mean your employer is taking too much out of your paycheck.
“Check your withholding to make sure it is correct,” Zigmont said. “It may be as simple as you got married or had a kid and didn’t update your withholding.”
If you’re self-employed or have 1099 income, Zigmont recommends adjusting your estimated tax payments.
“While you may not know exactly what you will make this year, you can use your current tax return to help estimate how much you need to pay each quarter,” he explained. “The simplest way tends to be to figure out your average tax rate for last year, and apply that to this year’s taxes.”
Zigmont noted that the average tax rate differs from tax brackets as it’s a blended rate across the brackets, which considers self-employment and other taxes.
You Owe Taxes
Finding out you owe taxes may be overwhelming, but you can make adjustments to prevent this from happening next year.
“If you owe the government a significant amount of money, you need to increase the amount of your withholdings and/or estimated quarterly payments,” Thomas Brock, chartered financial analyst (CFA), certified public accountant (CPA) and expert contributor for Retireguide.com, wrote in an email.
This could also reveal missed tax breaks.
“Make sure you are making the most of potential tax credits and income offsets,” Johns explained. “I was able to reduce a client’s tax bill by contributing to her Traditional IRA.”
Two of Johns’ favorite tax credits are the Educators Credit, a credit of up to $300 for teachers and aides for unreimbursed expenses, and the Savers Credit, which is a credit toward your taxes for the amount you save for retirement.
“It is always worth exploring any deductions and credits that might be available to lower a tax liability,” Johns added.
You Estimated Your Tax Return Accurately
A tax return near zero means you estimated your tax return accurately — which isn’t easy.
“Your overall goal should be to be within $500 of your tax bill, meaning you get back $500 or owe $500,” explained Zigmont. “It is hard to get it exact, but close works.”
The best way to get your tax refund as close to zero as possible is to work with a tax professional.
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