April 15th marks the end of tax season for most Americans. While thoughts of large tax refunds are still relevant to our minds, let’s have a much needed conversation. Did you know tax refunds are actually a bad thing? If you receive large tax refunds, you have been over-paying the government.
It makes complete sense if you think about it. Why else would the government be giving money back to you? It probably isn’t because they love you.
What Are Income Taxes
The best way I can explain income taxes is to think of it like a restaurant bill. After dining out, the waiter brings a bill for everything you ordered. It works similar with taxes. Think of all the programs and services provided by the government that federal taxes are used to pay for.
Here are the main programs our tax money contributes to:
- Medicare / Medicaid
- Social Security
- Defense and Security
- Interest on National Debt
- Low Income Assistance
- Transportation and Infrastructure
Imagine all of these programs being on the bill that the waiter brings back to the table. The people responsible for the bill are the American people. But here is the catch – the bill isn’t split equally.
Everyone has a portion of the bill they are responsible for paying. The amount depends on several factors – how much money they made during the year, how many exemptions they are allowed to claim, what credits they qualify for, etc.
Real Quick – here are some tax terms you should get familiar with:
- Gross Income – everything you have before anybody takes anything out. All your income before taxes, deduction, credits or exemptions.
- Adjusted Gross Income – taxable income minus deductions/exemptions
- Tax Credits – cuts the amount of taxes you owe; reduces your portion of the tax bill. Tax credits are given to you dollar for dollar, so you can actually end up with a refund if your credits exceed the amount that you owe.
- Deductions – expenses the IRS will subtract from your gross income to get to your adjusted gross income. Deductions reduce the amount of your taxable income by accounting for expenses you occurred throughout the year.
- Exemptions – the same as deductions, as it reduces the amount of your income that is taxable. However, deductions are a result of expenses throughout the year, exemptions are based on dependents.
How Taxes Affect You
Here’s what happens: When you start a new job, they give you a tax form to fill out. It’s called a W-4 tax form. Your employer uses this form to determine how much income tax to take out of your paycheck. It is up to you to determine the number of allowances you have.
Nine times out of ten, most of us fill that number in based on how many dependents we have. However, that is not correct.
The form asks for number of exemptions, not number of dependents. And this my friends, is where we screw up HORRIBLY. Because, if you’re a single mother with two children, you should be plugging in a number that is higher than two.
Think of exemptions as reasons you have to not pay. Think – “I am exempt from paying this because of xyz.”
The higher the number you plug in, the LESS they take out of your check for taxes. Let me say it again for the folks in the back, the HIGHER the number you plug in on your W-4, the LESS they take out of your check for taxes.
Most people, including myself up until a year ago, do not understand how the W-4 exemptions work, so they plug in the wrong number, get taxed all year incorrectly, ultimately overpaying the IRS and needing a refund of their money at the end of the year.
To give you an idea of just how much you could be overpaying, I adjusted my W-4 last year for the first time to match what I was actually responsible for paying and my total bill for the year was $130. FOR THE YEAR! They were taking more than that a paycheck.
They went from withholding $200 a paycheck to $11 a paycheck and because I have dependents, I still received a refund for the Earned Income Tax Credit. Though, the refund was much less than the $5000 people are used to.
Keep reading as I will explain why my tax bill was so low for the year and why yours might be too!
Scam: You May Not Even Owe Taxes If You Are Low Income
Here’s where stuff gets really scandalous – some people’s portion of the bill is $0. I’ll tell you right now, if you are living in low income housing, receiving SNAP benefits or disabled – you are probably one of the $0 people.
Why I say that: If you are under 65 years old and made less than $18,000 (gross) in 2018, your portion of the bill was $0. >>click here to read more on this.
In other words, you shouldn’t have had any income tax taken out of your paychecks at all. Imagine all that money you could have kept throughout the year.
Everyone knows the less money you make, the less taxes you pay. But just how much less, isn’t so common knowledge.
There’s A Reason It Isn’t Common Knowledge
Your over-payment of taxes basically gives the government an interest free loan…
Because most people unknowingly over pay their taxes by hundreds and thousands of dollars, the government basically gets an interest free loan from the people. Even though overpaid taxes do get paid back, the American people are not charging the government interest on income taxes. Therefore, interest free loan.
…but they earn interest on it and don’t have to pay that back to you
Meanwhile, for most of the year, they place all the extra money they’re getting from us into a bank account. Said bank account collects interest all year long.
At the end of the year, they pay you back the extra money you overpaid them. However, they get to keep the interest they made on it.
Essentially, they just made extra money off of your money. The same money that they weren’t supposed to have in the first place.
The same money you could have kept throughout the year and placed into a bank of your own to collect interest for yourself.
Large Tax Refunds Are The Reason Many People Struggle Paycheck To Paycheck Every Year
A lot of people could agree that their paychecks look decent until they see how much was taken in taxes.
If people really understood their tax breaks (think of the government cutting you a break on a tax) then they would be able to keep more money in their pockets throughout the year.
Unfortunately, most people aren’t properly informed on what deductions, credits and exemptions they qualify for or how to apply them to their W-4 form.
Keeping more money throughout the year means receiving much lower tax refunds, or possibly not receiving tax refunds at all.
Since you’d be paying exactly what you owe, instead of overpaying, there would be no extra money to return to you.
Some people still receive tax refunds if they qualify for credits that give them something back. (but, that’s another post for a different day lol.)
You can adjust your W-4 anytime during the year, not just at the start of a new job. As a matter of fact, you should adjust your W-4 anytime there is a major change in your life (new baby, marriage, loss/start of part time job, etc). When filling out a W-4, read the instructions line for line. The form actually walks you through each line.
Let’s start saving some of our money so we don’t struggle so much throughout the year!