Why It’s Not Smart to Get a Big Tax Refund Each Year

Why let the government hold your money throughout the year when you can put that money to work today?

If you’re expecting a big tax refund this year, you’ve probably already decided what you’re going to do with that money. Whether it’s a vacation, a new jet ski or a nice boost to your retirement savings, you’re probably pretty excited about the extra cash. But here’s the deal: Getting a big tax refund each year isn’t necessarily a good thing. It means you haven’t been putting that money to work for you all year long.

“If you are receiving a refund this year, it means that you overpaid your taxes during the course of the year. Instead of giving the government your hard-earned money, think about all of the great things you could have done with that money,” says Ron Weber, a senior marketing manager with Quicken Inc. “You could have paid off credit accounts, invested it in your future, and/or spent it as you earned it. Money is always better in your pocket than in someone else’s — even if that someone else is the government.”

Here’s how you can make sure you boost your bottom line this year by not overpaying your taxes and also not getting a refund.

Review Your Withholdings

Sit down and review your paycheck withholdings and see if you can break even when it comes to the taxes you pay. You’re looking for your Goldilocks zone. Not too little, not too much, but just right.

“If you are unsure what to do, experiment until you get it right,” Weber advises. “Most people are unaware that you can change your number of payroll exemptions as many times as you wish.”

You can also try using a tool to help you find your Goldilocks zone. The Internal Revenue Service has a withholdings calculator that can help you see how much difference a change in your withholdings will make. Certainly, you don’t want to owe taxes next year if you can avoid it, but getting your tax refund as close to zero as possible means you can invest or spend the additional income on a regular basis instead of letting the Treasury Department store it for you.

As you review your withholdings, you’ll want to be sure you …

Don’t Forget Your House …

If you own your own home, you probably know you can claim mortgage interest and property tax deductions, so take into account how much that will reduce your tax burden.

… Or Your Investments

If you own investment property, you’ll also want to consider any expenses you can deduct that might affect your taxes for next year.

… Or Big Life Events

“There are certain life events that you want to keep in mind when changing your exemptions such as marriage, having children or any situation where you decrease the number of dependents, such as divorce,” Weber says. “Also, keep in mind that while you are able to change the number of withholdings as often as you wish, your employer doesn’t have to apply it until the first payroll ending 30 days after you submit the change, effectively limiting the number of times you actually can change. Other than these considerations, the ultimate goal each year is to get your refund close to zero. Make it a game and see how close you can come.”

But You’re Terrible at Saving Money, You Say?

Of course, if saving isn’t your forte and you’re going to just end up spending whatever additional income you get throughout the year, letting Uncle Sam hold it for you might not be such a bad idea if you plan to put your refund directly into a retirement account like an IRA. The IRS will even help you keep your promise to invest the money by direct depositing all or part of your refund into savings, an IRA or even toward buying savings bonds.

If that’s your situation, you can read our guide on how to maximize your tax refund. But investing that money into a 401K throughout the year could be a better alternative, especially if your employer provides matching funds.

Those savings can pile up, especially if you start young. If you’re planning to turn your refund into the start of a lifetime of saving, check out our list of 50 things young people can do to make sure they’re set when it’s time to retire.

Also remember that keeping your credit in good standing helps you save money throughout the year, on everything from loan and credit card interest rates to mortgages. A good way to check on how your credit is faring is by getting credit your two free credit scores, updated every 14 days, on Credit.com.

Image: RapidEye

 

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Help! I Just Got a 1099-C — But I Filed My Taxes Already

Don't panic. Here's how to deal when a 1099-C appears in your mailbox after you've filed your return.

You finally did it. You filed your taxes and now need only await your return, to be spent on a new TV or stocked away in an IRA or whatever you want — it’s your money again, and not Uncle Sam’s.

Unfortunately, it’s possible for this state of reverie to be interrupted by something called the 1099-C — a form taxpayers receive when a creditor cancels a debt worth more than $600.

So if, for example, you have a student loan forgiven and the forgiven amount is more than $600, that counts as additional taxable income and you should expect a 1099-C in the mail. Or, if you renegotiate with a credit card company to pay less than you owe, and the difference is more than $600, expect a 1099-C. The form itself will give the specific reason in Box 6 via a code that you can look up on the IRS website.

No matter the exact reason, just know that, while it’s great to get rid of debt, it can still have consequences come tax time. Canceling a debt may also affect your credit score. Keep up with yours using Credit.com’s free credit report summary, which provides your two free credit scores, updated every two weeks.

Once you know why the 1099-C is in your mailbox, what do you do with it? The 1099-C might seem like just another form to plug into your tax software or give to your accountant. The problem is, the time the 1099-C arrives can vary, and the form may arrive after you’ve already filed your taxes, said Lisa Greene-Lewis, a CPA and tax expert for TurboTax.

Regardless of when the 1099-C arrives, if the debt was canceled in 2016, you have to include it with that year’s return, Greene-Lewis said. Here’s what you can do if you’ve already filed.

Amending Your Return

In some cases, you may not have to do anything. Your creditor should have filled out a 1099-C and sent it to the IRS when they forgave the debt.

The IRS may do an adjustment on your return automatically and send a notice asking if you agree. If not, you’ll have to amend your return, Greene-Lewis said.

Tax software like TurboTax can guide you through the process; otherwise, you’d file a form called a 1040X and include the information in the 1099-C.

Exceptions

You don’t have to report forgiven debt as income in a few cases. If a debt was discharged because of bankruptcy, you don’t have to pay tax on it. Same if you’re considered insolvent, Greene-Lewis said.

Also, if you had debt on a mortgage discharged in 2016, you don’t have to include it in your taxable income, thanks to the Mortgage Debt Relief Act’s extension through last year, Greene-Lewis said.

Will This Hurt My Return?

It depends on how much debt was discharged. If it was enough to bump you up to a higher tax bracket, then yes, a 1099-C could shrink your return, Greene-Lewis said.

In addition, you’ll likely pay a penalty if you file the amendment after April 15, even if the 1099-C showed up after the deadline.

It’s rare, but Greene-Lewis said she’s heard of 1099-C forms showing up after the filing deadline. You can include an explanation as to why you’re filing late on the amendment, but it’s not always enough to avoid the wrath of the Internal Revenue Service.

Image: AntonioGuillem

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Help! I’m Not Ready to File My Taxes. What Should I Do?

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You didn’t get your tax documents in order yet. You’re still waiting for a lost W-2. You just flat-out haven’t felt like tackling your taxes. Whatever the reason you don’t have your tax return completed yet, there’s no need to stress about it. Filing for a tax extension is a quick and painless experience that will give you an extra six months to file.

There are several important things you’ll want to keep in mind, though, if you’re filing a tax extension.

1. A filing extension is not a payment extension.

If you think you’re going to owe the IRS additional taxes this year, you’ll need to estimate on your extension (Tax Form 4868, which you can free file) what you’re going to owe and go ahead and pay that amount by this year’s deadline of April 18.

If you end up overpaying, you’ll get a refund. If you under-pay, you could owe penalty and interest on the amount you didn’t pay. Here’s a breakdown of the penalties and fees you may owe the IRS for filing or paying late.

2. Can’t afford to pay? Review your options.

If you’ve been putting off filing because you know you owe and just can’t afford to pay your taxes due, you should immediately contact the IRS to ask for an installment agreement, so you can pay what you owe in smaller amounts over time.

When you enter into the payment plan, the fees and interest will be assessed to the end of your agreement, so if you plan to pay off the debt before the end of your agreement, contact the IRS to adjust your installment amount.

Consider all your options: Using a personal loan or credit card to pay your taxes on time may be cheaper than what you’d owe the IRS by the time you factor in all the penalties, though generally a payment plan with the IRS is your best bet.

Also, failing to file your extension by April 18 results in a late-filing penalty, which is why it’s important to file on time.

3. Don’t bury your head in the sand.

The worst thing you can do when dealing with unaffordable taxes is ignore them. If you owe tax debt, the IRS can take serious enforced collection action, such as taking money from your bank accounts, wages, or other income. In general, they have many more options available to collect your tax debt than do other companies you may owe money to.

The IRS may send a debt collector to retrieve the funds you owe, or if you owe $10,000 or more and can’t pay it right away, the IRS may file a Notice of Federal Tax Lien. Tax liens are reported to the major credit bureaus, and are considered very negative information so your credit scores can drop significantly as a result. If you’re concerned about how tax debts might be affecting your credit, you can get a free credit report summary on Credit.com.

Under the federal Fair Credit Reporting Act, tax liens can be reported longer than any other type of negative information — seven years from the date they are paid. However, under the IRS Fresh Start initiative, you may be able to get a tax lien withdrawn and removed from your credit reports once you pay it, or enter into an installment agreement, which we’ll discuss in a moment. That’s all the more reason to find a way to work with the IRS rather than avoid paying.

More on Income Tax:

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