Hopefully you’ve all done your taxes (or you’ve filed for an extension) because today is the day! I know what you’re thinking… “Why are you writing about taxes? This is so boring!” But, before you leave this post at least take some time to read the short version because whether you like it or not, if you’re a U.S. citizen you will probably have to keep doing taxes for forever. Even if you work abroad because the IRS will hunt you down.
For those of you still reading…carry on.
I’m writing this post because ignorance is not bliss. Just because we may find taxes or other personal finance matters complicated, intimidating or just flat out boring doesn’t mean we should remain uneducated about them. These things are important! Don’t cripple yourself in the future by remaining ignorant. KNOWLEDGE IS POWER! We have the internet with a zillion resources at the tips of our fingers. And now we have my simple blog post!
* Please note this post is based on my personal experience filing my own federal taxes and that I am not a CPA or accounting professional.*
First, some background on how the U.S. tax system works
The federal government is supposed to collect taxes as you earn money, which is why you will see money from your paycheck withheld for state and federal taxes. Think of it as a “pay-as-you-go” plan. Ideally the government collects just the right amount of taxes all year long with each paycheck so that at the end of the year you owe $0.
What if the government collects too much? Then they give you a return in the face value dollar amount. (They collect $100 too much, you get a return of $100). Collect too little? That’s when you owe the government a check.
The money withheld from your paycheck is just an estimate and doesn’t account for other factors that might affect your taxes, such as moving expenses, getting married, tax-deductible donations, etc. So, when it comes time to do taxes, most people end up owing or receiving money.
I still don’t see why a tax return is bad
When you get a tax return, you’re getting just that – a return. I’ve heard this feeling described as “intaxication,” the euphoria of receiving a tax refund, which lasts until you realize it was your money to start with (and you were robbed of the chance to invest it for months).
Let’s say the government over taxes you by $100 in January 2014. For all of 2014 the government holds onto the $100 only return it to you in April 2015. Well, over a year later that $100 is worth less to you because of time value of money. If you were to deposit that $100 into a savings account in January 2014, it would earn interest by April 2015.
When your money just sits with the government it’s not working for you. You can’t use it and you can’t invest it. It’s as good as taking your money and putting it in shoebox under your bed. With $100 the interest earned from a savings account might not be that much, but what about interest earned from $1,000? $2,000? And what if you were putting $1,000 into stocks or mutual funds, which have a higher rate of return than a savings account?
Even if you’re not a pro at finance (which I’m not), just think about what you could have done with that $1,000 last year: Paid your rent, invested, used it for your emergency fund, bought a new bike, etc.
So what can I do?
If you’re getting a really big tax return each year, but want to decrease it, the solution is simple. Talk to your HR department about adjusting the amount of taxes withheld on your paycheck. You can also do this if you’re having to pay a big return each year.
But I love Extra Money!
Some of my friends have mentioned they like to treat themselves with the “extra” money from their tax return so they like to have more money taken out from their paycheck so they can receive a bigger return.
This sounds like a weird way of budgeting. Again, it’s NOT extra money. It was already your money to begin with.
Why not just create a budget for special expenses? You can invest your disposable income in a high-yield savings account at the minimum to try to get some sort of return from it or at least make sure its value doesn’t decrease from inflation. Then when it comes time for a treat, you can just pay yourself by transferring from checking to savings. If you need help on budgeting…well that’s whole other post, but I do recommend using Mint.com to help keep track of your spending.
I hope this made sense and wasn’t too boring. Congratulations on making to the end of the post…oh and not having to do taxes until next year!
Don’t wait a year for a huge tax return. Get your money sooner rather than later!
- The U.S. tax system is “pay-as-you-go” tax, so taxes are withheld from each paycheck as you earn money. Ideally at the end of the year the government will have collected just the right amount so that you won’t owe or receive anything.
- When you get a tax return, the government is not giving you extra money, it’s simply return money that was already yours because they accidentally overtaxed you the previous year!
- The dollars you get back today are worth less than they were a year ago because of time value of money.
- If the government holds onto your money for a year you are missing out on the opportunity to invest or earn interest.
- If you receive a high tax return each year, you may want to talk to your HR department about adjusting the tax withholding on your paycheck so you can get your money sooner rather than later.
Have questions, advice, or angry rants about taxes? Leave a comment!