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Tax Refunds Are Bad

 

Here’s Why:

Getting a big check of money is a good thing, isn’t it? Not if it was your money to start with, and you should have had it months earlier.

 

Many tax preparers, like H&R Block (“Get your $ Billions Back America” – commercial), love it when they get to tell you that you are getting money back, rather than having to pay more taxes. This is always a happier message, on the surface, and helps ensure that they get paid, out of the money that you should have had long ago.

 

Many people get substantial refunds when they file their federal and state tax returns each year. A few people get large Child Tax Credits and Earned Income Tax Credits. If your combined child and earned income tax exceed the taxes withheld from your paycheck, then this article is NOT about you. Get all the credits you can out of the government, even if it results in a tax refund.

 

However, if you are having any taxes taken out of your paycheck, AND you get a tax refund at the end of the year, then you are doing it WRONG. Your exemptions filed on the W-4 form with your employer are too low, resulting in the employer withholding more taxes than they should, which in turn means that you have to wait to get that extra withholding back the next year when you file your tax returns.

 

Don't Have the Government
Run Your Savings Account

Here are the problems with getting a tax refund:

 

1.         You have no control out of the extra money your employer has withheld from your paycheck. The only time you can, hopefully, get it back, is in February of the following calendar year, at the earliest. If you need the money for an emergency, say a car repair, in October, you are just out of luck. You may then have to borrow the money, often at high interest, or worse, via a pay-day loan, at triple-digit interest, to tide you over until your refund is available.

 

2.         You can’t earn any interest on the extra money that your employer has withheld, and that is locked up by the IRS. While interest rates have been quite low, they will go back up at some point, and make it even more expensive for you to be getting a tax refund.

 

3.         Tax filing fraud is a huge problem, with no end in sight. Tax filing fraud involves someone else (usually in another country) filing a tax return as though they are you, and getting a huge tax refund. Then, when you file your tax return, hoping to get your refund, the IRS says “Sorry, you tax refund has already been issued.” You have at least a year’s worth of proving the fraud to the IRS, before you can get your refund, on top of the time that you have already had to wait since the extra money was taken from your paycheck.

 

4.         If you owe any creditor any money, they may get your refund, and not you. The money that should have been in your hands all along the previous year, may now instead go to pay some debt that you owe. The IRS WILL not pay you a refund if you owe them money. The state tax boards often works with the IRS to grab any refunds for each other. Any judgment creditor can also intercept a tax refund, including student loan lenders, credit card companies, and even private individuals.

 

5.         In a Chapter 7 bankruptcy case, you may lose the vast majority of your tax refund. If you have substantial equity in your home (it’s worth more than you owe), then there is NO protection for tax refunds in bankruptcy. You will lose all of the extra money withheld from your paycheck up to the time your case is filed.

 

6.         In a Chapter 13 bankruptcy case, you may lose the entirety of every tax refund for UP TO 5 YEARS. Depending on how your bankruptcy payment plan is structured, your unsecured creditors may end up getting some, or all, of your tax refunds, rather than none of them, if you had properly set your exemptions with your employer. This could cost you more than $10,000 over the life of your bankruptcy plan.

 

If you want to receive a big chunk of change in February of every year, then YOU should take some money out of every paycheck, and put it into YOUR savings account. This way, you will have control over the money, can earn some interest on it, and can’t lose it so easily to fraud, or any of your creditors.

 

What happens if you have an emergency need for money in October, and the only extra money available is in the form of next year’s tax refund? You might then be tempted to not pay off your credit card balances, or even worse, get sucked into pay-day loans, with their outrageous interest rates. Set your exemptions properly on your paycheck, and use the extra money to set up a proper emergency fund.

 

The Goal

Ideally, every tax payer (except for those with big tax credits, as mentioned earlier) should OWE to the IRS, and to the state tax board, about $100 each, when your taxes are due, in April of the next calendar year. This means that you have had just about the right amount of money taken out of your paychecks, and no one can use a fraudulent tax return, or a refund intercept, to take your money from you.

 

How to "Fix" Your Refund

Every tax payer should adjust the exemptions they claim on the W-4 form filed with their employer EVERY TIME a significant change happens in their life that has an effect on the amount of taxes they have to pay. This includes the birth of a child, the purchase of a home, a large increase in the amount of goods or money donated in a year, a significant change in income, marriage or divorce, among many other changes.

 

If you do not know how to adjust your withholdings to keep your tax refund low, then contact a CPA that specializes in tax return preparation. Many CPAs charge less than H&R Block type preparers, and can give you much more accurate advice on your taxes, both past and future. Please keep in mind that I am not a tax professional; I just see the problems that tax refunds cause.

 

Do It Right

So again, for most people, getting a tax refund is simply bad financial planning. If you have any amount of federal or state taxes taken out of your paychecks, and then you get more than $100 in tax refunds, you are doing it WRONG, and putting yourself in financial danger.

 

            See my Life After Bankruptcy article at OrthnerLaw.com for more information on managing your money properly without losing it to tax withholding, or paying any bank fees. Feel free to contact me with any questions you may have.

Dale Orthner

Dale@OrthnerLaw.com

(916) 588-5011

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