Tax Refunds

“If ever there was a time to review your withholding of federal income tax, this is the time.”

I cannot pass up this opportunity, which only comes at this time of year. It is, of course, “tax season.” For some it falls between January 31–about the earliest you can get copies of all the documents needed to file–and April 1. For others, it starts on April 1 and can run up to midnight on April 18, the last deadline this year to file taxes without penalties for dollars you owe to the IRS.

Last year the average federal tax refund passed the $3,000 level, a 10-percent increase from the 2008 tax year. An even more amazing statistic is that 4 out of 5 taxpayers will receive a refund this year.

Those people fall into the early file category above, because they want to get that huge lump-sum payment from Uncle Sam ASAP. (I’ll get back to that lump sum at the end of this column)

The latter group, those who file at the last minute, do so because they either owe some additional taxes, or they have a very modest refund coming. I am in that group, and I am going to tell you why we should all be in that 15-day filing window.

If you divide $3,000 by 12 it gives you a quotient of $250. That is the average amount of money taxpayers “lend” to the federal government each month with no possibility of growth in interest or dividends.

To my way of thinking, that is very poor investing.

In a few years there will be an even more compelling reason to quit giving the federal government that annual interest-free loan. If the Supreme Court upholds the current version of the health care reform law, failure to purchase health insurance will be punishable by a fine.

Where do you suppose the money to pay that fine will be collected? If you responded, “It will come from my tax refund.” Go to the head of the class. That’s right, the IRS will deduct the fine from your refund if you cannot provide proof of health insurance.

A better way to pay taxes is to estimate how much you will owe on April 15 and then have the correct amount withheld periodically as it is earned. The goal is to try to be within $100 of you total tax liability when you file.

If your income is mainly derived from a paycheck that you receive from an employer, you can easily change your withholding by filing a new W-4. Just ask your employer for the form, or you can download one from the IRS Website: http://www.irs.gov and then turn it over to your payroll department when you complete it.

There is an easy way to calculate the optimum number of allowances on the W-4. Go to the Kiplinger Website:
http://www.kiplinger.com/tools/withholding/index.php
and follow the easy steps. You might want to read the entire set of pages there as well, since Kiplinger gives excellent advice on the subject.

Even if you were to miscalculate (under-estimate) your optimum withholding amount, you can always file quarterly estimated taxes to catch up without penalty. The 1040ES form and instructions are also available at the IRS Website to help you.

The 1040ES is the same form you should use to file quarterly estimates if your income is from other sources, such as self-employment, pension, Social Security, interest or stock and bond dividends.

Now, back to that big refund of $3,000... There were approximately 221million taxpayers in the United States as of 2009. That includes a lot of families where only one tax return is filed for multiple citizens. Because of that, and because the earliest year I could find the actual number of individual tax returns filed was 2005 (134,372,678), I estimate the total number of returns in 2010 to be about 140 million. 112 million of those returns—4 out of 5—generated the average $3,000 refund last year. Simple arithmetic gives a total interest-free loan of $336 billion.

Let me write that out for you: $336,000,000,000. Even though those refunds go out every year, our system of tax withholding means that the federal government has a continuous use of that money—in effect, a gift that keeps on giving.

Wise up America! You can certainly use that extra $250 per month better than Uncle Sam can.