Did you get a tax refund? It’s exciting, isn’t it? Now, the question is: What should you do with it? You could take a vacation, pay down debt, invest it, or fund a retirement account. The possibilities are endless! Whatever you do with the money, however, there’s one more vital task to complete as soon as possible: Discover why you received that refund.
Every year, the IRS sends more than 55 million refunds totaling over $170 billion. Many Americans look forward to getting that refund. However, tax professionals tend to view it differently. You see, a tax refund isn’t free money from the government. It’s your own money that the IRS is returning to you. Essentially, you gave the government an interest-free loan, and it’s now being paid back.
The average tax refund is about $3,000. That’s $250 each month that you could use for yourself. When you consider interest-bearing accounts—whether it’s debt or the interest is working in your favor—that $250 each month could be worth much more than its face value by the end of the year.
That’s why it’s important to do some detective work to discover why you received the refund. If you or your spouse gets a paycheck—whether from an employer or self-employment—review W-4 withholdings carefully. The form received a complete overhaul in 2020, which could have affected the allowances that make sense for you. More recent tax bracket changes to counteract inflation may have also resulted in more money back.
Otherwise, a substantial life event or change in income resulting in a reduction in taxes could have been the culprit. Any number of tax deductions could result in a sizeable refund. These include big life events, such as the birth of a child, significant medical expenses, or a large, deductible purchase. Home deductions alone can play a big part, including handsome deductions for solar installations and home office or medical accessibility renovations. Business owners and those with extra sources of income may overpay their estimated quarterly taxes due to miscalculations or unanticipated deductions.
Unexpected tax refunds happen from time to time. But if you’ve come to expect one, you may want to consider the factors above and contemplate whether sharing less money with the government is a wiser option moving forward. Feel free to contact us with questions.
