Rethink Your Payroll Tax Withholdings Before 2017 Kicks Into High Gear

Adjust your paycheck to eliminate a tax refund

Image Source: Flickr User Angy Nguyen

Some Americans get excited in Spring because it means the arrival of blooming flowers and fat income tax refund checks. Many love that they get several thousand dollars back from the U.S. government and see it as a windfall. Some use it to pay down debt, some to plan their summer vacation. Others will splurge on something they want or need and some will put it straight into savings. But few think about the fact that what would be much better is to get no refund at all. Here’s why.

#1 A Refund Is Your money, Not a Gift From Uncle Sam

Some consumers feel like a tax refund is a “gift” from the government and something to be thankful for, but it’s not. A tax refund is your money. It’s money you overpaid to the U.S. government and they kept it instead if you. If your refund is $3k, that’s an overpayment of $250 each month. Would you give $250 a month to someone else and ask them to hold it all year long then hand it back to you? Of course not.

#2 The Impact on Your Debt Can Be Considerable

If you’re living paycheck-to-paycheck, an extra $250 a month could go a long way to making more room in your budget and getting you out of debt. That’s enough to pay your utilities, buy groceries for your family, pay your auto insurance, car loan, or other costs of living. You shouldn’t run late on bills because you’re letting Uncle Sam keep and use your money for a year. There’s a better way to handle finances.

#3 Tax Refunds Are an Interest-Free Loan to the Government

If you’re not running behind on bills and don’t need that money to go towards debt, you can put that money in savings or your IRA or retirement account. That means it will earn interest or dividends or another positive financial outcome that will benefit you. Letting the government use your money is like giving them an interest-free loan. Why would you do that? You shouldn’t.

#4 State Tax Refunds Can Increase Federal Taxable Income Next Year

In addition to adjusting your federal income tax withholdings to avoid a refund, you might want to examine your state taxes as well. If you overpay state taxes and are issued a refund, that can result in the issuance of a 1099-G and that amount must be listed on line 10 of your federal 1040 tax form under income. That can mean higher federal taxes that must be dealt with later. Why bother with that?

#5 Refunds Are Common Targets of Identity Theft

Income tax fraud is growing more common and you don’t want to fall victim to that. With income tax refund fraud, a scammer files a fake return before you file your real one. They use fake information to score a refund check. The IRS often pays the scam return and then you’re left without your refund and waiting until the IRS sorts out the fraud. If you’re not owed a refund, that can lessen the sting.

#6 You’re More Likely to Blow the Refund

One thing about a lump sum windfall is that it’s tempting to blow it all. If you use it to pay down debt, that’s not so bad nor is it if you put the cash into savings. However, if you use it for a vacation or other spendy item, that’s not a good idea if your bills and finances aren’t under control. Having more money year-round may help your finances more than one large chunk in Spring.

#7 Tax Refunds Are Worth Less Because of Inflation

Inflation runs an average of three percent a year in the United States. That means not only are you giving Uncle Sam an interest-free loan by letting them keep your money throughout the year, you’re losing money to do so. That equates to you paying three percent to let the government hang onto your money. That’s not a wise financial strategy for anyone, no matter the state of your finances.

How to Change Your Payroll Withholdings

Before you tinker with your W-4 (the document that determines your payroll withholding), look at a tax withholding calculator online. Tools estimate your optimal withholding based on anticipated income, deductions, credits, etc. The IRS app is free on their site - just search “withholding calculator.” Smart Asset offers a North Carolina state tax calculator as well. The links to both are below.

Be aware that you also don’t want to under-withhold and end up owing the government. That can burden you with debt that you don’t need. If you can work it out so you have to write a very small check or get a very small refund, that’s the best scenario to keep the maximum money in your pocket. Around September, rerun your tax estimator to make sure you're still on track and tweak withholdings again, if needed. Plus, if you don’t need the extra in your paycheck, consider upping your 401(k) contributions.

If you’re living paycheck to paycheck, are deep in debt, and looking for a solution, bankruptcy might be the best solution for you. Contact the Law Offices of John T. Orcutt today. Call +1-833-627-0115 now for a free North Carolina bankruptcy consultation at one of our locations in Raleigh, Durham, Fayetteville, Wilson, Greensboro or Wilmington.

Resources:

Federal withholding calculator 

North Carolina state withholding calculator