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Disclaimer: I am not a tax professional nor an accountant. You should review your situation with a tax professional or certified accountant before employing any advice here.
The hot topic at work lately has been “When I get my taxes back…”. For a lot of people, tax season is a payday… a pretty big one. They make plans and hold out all year for taxes to come back so they can make that one big purchase. I don’t understand this kind of thinking, and here’s why.
It’s a horrible savings plan. I talked to one girl who said she withholds extra taxes every year just so she can get a refund. She said it’s like her savings account because she’s terrible at actually saving money. If using your tax withholdings as a savings account is your justification, you need to sit down and think about this. When you withhold taxes, the government puts that money into its own “savings” accounts. Those accounts make the government interest (or maybe not, depending on how they invest it). So, you’re paying the government to make money off of your money! And will you see any increase in your refund if they make a return off it? NO! In fact, depending on the market that year, inflation and such may actually cause your money to LOSE value by the time you get a refund. It’s one of the only non-insured savings accounts out there.
Refunds breed a mentality. If you are the type of person that lives from paycheck to paycheck and have a hard time saving your money, then what are you going to do when you all of a sudden have an extra $xxxx in your bank? Well spend it of course. If people were a little smarter they would invest or capitalize their refunds. Instead, most people will blow their refund within a month’s time. After the refund’s gone, what happens with the extravagant spending style? It’s still there. This is dangerous ground, especially if you have credit cards or other lines of credit. No one really wants to stop spending, and people get into debt.
Your refund is taxable. If you get a large refund this year, guess what? It’s counted as income next year! That means your taxes get taxed next year, which will increase your tax liability next year. How’s that for getting screwed?
Okay, so we’ve established that getting a refund sucks. What do I do? Well there are a lot of options available when it comes to withholding and paying taxes, and a lot of it depends on what kind of money-maker you are. Here’s a rough breakdown:
1. Own a company. The ideal system would be to own your own LLC or S corporation and pay your taxes quarterly (or monthly, depending on your income). In the screwed-up tax system we employ here in America, corporations have the least amount of tax liability. This isn’t because they are actually liable by tax-code to pay less, but because a company can claim a LOT more deductions than an employed individual. (side note: the individual will ALWAYS get screwed in the US tax system, no matter how the politicians dress it up) This means that a company making $250,000 a year may only pay 15-20% in taxes whereas the individual making the same in salary may pay 35% or more.
2. Withhold your own taxes. This is personally what I do with my current job. Because the government really only cares about how accurate your taxes are when you file them, and because withholdings are only an estimate anyway, you can basically withhold (or not) any amount you want. Because of this, I list 99 exemptions on my withholdings form, which means I pay zero tax withholdings (but still Social Security and Medicare). Because I know roughly how much money I will make in a year, I figure out my tax bracket and have my employer deposit that amount every pay period into a separate savings account. All year long, my taxes are earning me interest and when it comes time to file, if I end up owing taxes, I have the money there to pay them…plus a little extra. If I don’t owe taxes, my refund is all there…without having to wait up to a month to get it!
If you’re concerned about spending your tax savings if it’s there, open an account at a totally separate bank and “forget” about it. Most employers will allow you to direct deposit to separate accounts on the same paycheck, so check out the possibility.
In the end, your goal should be to PAY taxes, not receive them. Getting a refund means you paid too much to the government or that you don’t make enough to support yourself (according to the gov’t)….or both. How is that a good thing?
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