Why Owing the IRS is Better Than Receiving a Large Refund

by Jessica Sommerfield · 9 comments

Tax season is something that comes around the same time every year. Yet, it still creeps up on us and leaves us wondering if we’ll be getting a refund or break even.

Considering the simplicity of my taxes, I almost always received a refund of some amount, and admit that it’s something I look forward to in the bleak mid-winter months.

Receiving a sizable refund also makes it easier to put a bigger dent in your debt, start an online savings account or retirement account, or place a down payment on a house. But, other than the perk of getting a chunk of money at the end of the year, is getting a large tax refund a smart choice, financially?

Let’s take a look at the facts.

Interest-Free Loan to the Government

Did you realize that when you’ve overpaid your taxes all year, and receive a large refund, that you’ve literally been lending the government money interest-free?

This might not bother you at first, but if you think about it, there are probably much better ways to spend that money if you had access to it all year. Instead of overpaying your taxes, had been placed in a savings account it would have earned you money in interest!

Take a look at how much money you received for your last tax refund, and divide it by twelve months. Then calculate the average interest rate your savings or investment account would have paid, and how much more money you could have had at the end of the year.

If nothing else, that should bother you. One financial expert estimates that if you receive a $3,000 refund, it represents about $250 a month you could have used in your budget.

Forced Savings Method

You may have a hard time setting aside money from each paycheck for savings, so a large lump-sum payment in the form of a tax refund is a good way to save without having to think about it (a method of forced savings, if you will).

This could be a smart idea, but the problem with this view is that you’ll be waiting the entire year to also utilize that savings or invest it. You’re missing out on interest payments, and other ways to leverage your income to work for you.

Afraid of Underpayment

In spite of the financial logic of only paying the government what you owe, you may be concerned about owing taxes at the end of the year, so you’d rather cling to the security of knowing you’re overpaying instead of underpaying.

Owing the government a little bit of money for taxes isn’t a big deal if you’re prepared, but calculating your taxes so you break even is ultimately the best option. Having the mindset of underpayment security by deliberately paying too much is throwing a large bill at the drive-through attendant instead of finding out what you owe.

Take the time to calculate your taxes, and find out if you need to save more, or if you’re on track.

Tools to Calculate Your Taxes

First of all, the IRS has a tool on their site that can help you calculate what you’ll owe in taxes all year and how much you should have withheld each paycheck. This is especially helpful if you’re self-employed or an independent contractor who will be paying your own taxes and don’t want to get stuck with the bill all at once.

If you’ve done well at estimating your withholding in the past, be aware that any major life changes, such as status, having children, buying a house, or opening a business, can drastically impact your tax bill.

The personnel director at your job should also have insight into general tax withholding tips, or who to contact for further advice.

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Receiving a tax refund may be a hard habit to break. After all, who doesn’t want to receive a surprise lump sum of money? But it may make more sense for you to owe the IRS a small amount, than to overpay throughout the year.

In spite of habit, understanding the financial implications can help you realize that receiving a large refund might not be the best decision, and change your mentality towards tax refunds forever.

Do you agree with this? Should you receive a smaller refund and risk owing the IRS? 

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{ read the comments below or add one }

  • Dan says:

    I wish everyone would stop referrind to this a tax refund. This is your money not the Government giving you their money back. If we had to write a check each month to pay our taxes, the system would have a better chance of being fixed.

  • We tend to have to pay in each year. It stinks, but I would rather have it this way that be giving up more of my money each paycheck to the government than I need to. Sure the idea of a refund is nice, but at the end of the day, you are really putting yourself into worse financial shape by not having the money in your paycheck to either save and allow to compound or pay off debt.

  • Kayla @ Everything Finance says:

    I’d rather get a refund than pay in for sure, but I don’t like having a HUGE refund either. A happy medium is always good.

  • Chris Martin says:

    Thank You! This is exactly the position I have taken for years. The potential of money is its ability to earn more money and leaving it tied up with the IRS does nothing to help that. My family is on a journey to beat back debt and regain our freedom. Things like this are how ere are making that possible.

  • Walter says:

    Sorry but I disagree somewhat with this line of reasoning. I done taxes for as many as 40 clients every year until 2009. I would see those big refunds and point out how they could use the money during the year and not let the government use it for free. Now being retired and not living paycheck to paycheck I see the benefit of getting a larger refund under my circumstances. In fact I have changed my pension exemptions to zero and have the SS hold out 15% of my benefit. I’m getting over $4,000 from both state and federal. My wife has a money market account with over $8,000 for the entire year and the interest earned was horrendous. She earned less than $20. It was an insult. We are planning to deposit some of the refund into her MM account and some into our emergency fund. It’s a heck of a lot easier to dole it out that way than it is to discipline yourself and set aside a like amount each month. It’s one less thing to keep track of in your budget. We try to save all the refund in one account or the other for the last 5 years. We are much further ahead than I could imagine myself if I had to make a deposit each month. Control your budget don’t let the budget control you.

  • Glenn says:

    Wait a second … it took a financial expert to perform the math that a $3K dollar refund could have been about $250 per month in your monthly budget! I would need a calculator and an hour to confirm that.

    If instead I took that $3000 and received a 3% yield, that would give me $90 for the year. That’s assuming that it was invested for the year, but it wouldn’t be, it would be invested $250 per month over the course of a year. Realistically, it would be closer to $50. I would rather have that $50 than not have it (though taxes would be owed on that $50, so it is closer to $35).

    My personal goal is to not pay in April (or receive back) more than 3% of the total taxes owed. To achieve that, each August/September, I calculate what I should have paid year to date, forecast what I expect to owe for the remainder of the year, and then adjust my withholdings accordingly.

  • D. Johnson says:

    I’m in the middle. I don’t agree with letting the govt. take the max out of my checks and use me as a 0% line of credit, but I also don’t want to owe them. I believe in finding that fine line, even knowing I have a small amount returning during tax season is okay. That’s an extra boost to savings I didn’t account for essentially, or an amount I can splurge with a little.

  • Benji says:

    I totally agree with this article! Uncle Sam already takes more than his fair share of our money. I would rather not be their banker for 11 months of the year. As long as you plan ahead and don’t live paycheck to paycheck, paying a small tax bill is not a huge deal.

  • Alexis says:

    Sorry, I disagree. I work on a contract basis (not a 1099) with an income that is unpredictable and can vary greatly from year to year. I would much rather live with “forced savings” and receive a large refund at the end of the year than have to scramble to write a sizeable check. Also, since tax season coincides with other large payments (professional dues, homeowners insurance and property taxes) this is one less thing to worry about during a stressful time.

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