How to Reduce Your Tax Refund (and Why You Should)

Share:

Facebook Tweet mail
blog post author image

Written by: Ashley Lee | Best Company Editorial Team

Last Updated: July 16th, 2020

Are you looking forward to a big tax refund this year?
 
According to a recent survey by FinanceBuzz, the ideal situation for 79 percent of American taxpayers is receiving a tax refund, rather than owing money to the government or even breaking even on their taxes.
 
And for the most part, it looks like they’re getting their wish: In 2019, about 72 percent of tax returns filed resulted in a tax refund, for an average amount of $2,729, according to the IRS.
 
After all, who doesn’t like getting a check for nearly $3,000?
 
But there are reasons to avoid getting a large tax refund.
 
"A tax refund is not free money," says Alexa Serrano, Finder's Banking and Investment editor. "It just means that you overpaid your taxes throughout the year."
 
Because when you receive a tax refund, "that’s your own money you’re getting back," says Pamela Yellen, founder of Bank on Yourself and a New York Times bestselling author. "You’re giving the government an interest-free loan, while getting a zero rate of return on your money."
 
So what's a smart taxpayer to do?
 
Megaphone Icon

Key Takeaway: Understand your tax responsibilities.

  • Keep more of your money throughout the tax year so you have more money to invest.
  • Use last year's tax return as a road map for this year's taxes.
  • If you receive a large refund, try increasing your allowances on your W-4.
  • Minimize your tax liability as much as possible.

Determine your tax strategy

The best option is to break even — don't receive a tax refund or owe money to the IRS.
 
Although it's nice to get a big chunk of change in the form of an income tax refund, you can put that money to better use if it's available to you throughout the year.
 
For example, instead of receiving a large tax refund all at once, you could set aside that money throughout the year and invest it, deposit it in a high-yield savings account, or put it in your retirement account. That way, instead of loaning money to the government interest-free, your cash earns interest for you.
 
On the other hand, although many experts advise against getting a large refund check, that's not one-size-fits-all advice.
 
“Deciding whether you want to owe taxes or receive a tax refund comes down to your personal goals and financial lifestyle," Serrano explains.
 
In an ideal world, we'd all regularly deposit money into savings or investment accounts, so it could yield interest over time. But the reality is that many of us struggle to save money if it's just sitting in our accounts, available to use at any time. If that sounds like you, it may be a better strategy to pay more to the IRS throughout the year.
 
"If you don’t have it, you won’t spend it," notes Peter J. Greco, a CPA and founder of the CSI Group, LLP. "It is basically a forced savings account."
 
But “if you consider yourself financially responsible, you might want to opt out of receiving a tax refund at the end of the year," Serrano advises.

And if you can't break even, the next best option is to owe a small amount, according to many experts. Just remember that the key is "small." "If you owe too much, you might just have a penalty for failure to pay estimated taxes," warns Steven J. Weil, an enrolled agent and president of RMS Accounting.

Josh Zimmelman, owner of Westwood Tax & Consulting, suggests putting extra money throughout the year toward your emergency savings fund.
 
"Worst case scenario, if you still end up owing taxes next year, you’ll have that extra money saved to help pay it," Zimmelman points out.

Estimate what you might owe next tax year

Taking a look at last year's tax return is a good way to gauge what you might owe next year — or at least how much you should pay to avoid owing penalties to the IRS.
 
Ben Watson, a CPA and personal finance expert from DollarSprout.com, offers a few suggestions:
 
1) Pay 100 percent of your tax liability from last year, or 110 percent if you're adjusted gross income is $150,000 or more and you're submitting your tax return as Married Filing Jointly.
 
2) Pay 90 percent of your tax liability for the current year.

Re-examine your withholdings

When was the last time you looked at Form W-4?
 
Withholding is what ultimately determines the size of your refund.
 
“If you withhold too much, you might get a big refund, but you’ll likely be short on cash all year," Zimmelman warns. "If you withhold too little, you might find yourself owing money in taxes again next April.”
 
According to FinanceBuzz's survey, 89 percent of taxpayers are confident their withholdings are set correctly. But if you're receiving a large refund, that generally means you're not claiming enough withholdings.
 
If you don't know where to start, try the IRS's online Tax Withholding Estimator. And then make sure to revisit Form W-4 at least annually.
 
"If you typically receive a large refund, you’ll want to increase your allowances," Serrano says. "If you owe the IRS, you’ll want to decrease your allowances. You can submit a revised W-4 form to your employer at any time."
 
Just make sure to proceed carefully — owing a large amount of taxes isn't an antidote to the large-refund problem.

Re-evaluate throughout the year

Depending on what's going on in your life, once a year may not be frequent enough to check your withholdings. If you experience a significant tax event, such as getting married or having a baby, you probably need to take another look at the W-4 form.
 
You should probably also pay attention to changes in tax law that might affect you.

Minimize your tax liability

The goal in avoiding a large tax refund isn't to pay more money in taxes; it's to keep as much of your money for as long as possible.
 
One part of that is to claim every tax credit and all the deductions you can on your tax return.
 
"A lot of people don’t itemize their deductions anymore because the standard deduction has been increased, but there are still ways to lower your tax liability even if you don’t itemize," Zimmelman says. "There are a number of tax credits and exemptions."

Expedite your tax refund

If you are expecting a refund, make sure you get it as quickly as possible by using direct deposit. There are multiple benefits of getting your refund through direct deposit:
  1. You'll receive your refund faster than if you'd opted to receive a paper check.
  2. If you're using your refund as a "forced savings," you can have it deposited directly into a savings account.
  3. It saves taxpayer money — according to the IRS, every paper check issued costs taxpayers $1, while every direct deposit costs only 10 cents.
 
You can receive your refund via direct deposit whether you're filing electronically or with a paper tax form; just select direct deposit as your refund method via your tax software, tax preparer, or Form 8888. Be ready to provide your bank account number and routing number.

Talk to a tax expert for personalized advice

It's hard to actually break even on your taxes; it's more likely you'll be able to ensure a small refund or a small amount of taxes owed.

"Working with a financial professional, like a CPA, can help ensure that you are paying enough taxes to avoid a penalty without providing the government with an interest-free loan," says Dewey Martin, professor emeritus from Husson University's School of Accounting.

“Don’t wait until next April to start your research," Zimmelman advises. "If you find it too confusing, hire a professional to help.”

The Top Tax Relief Companies

company logo
#1 Tax Defense Network chevron_right
9.5 Overall Score
4
starstarstarstarstar_border
(2,433)
company logo
#2 Optima Tax Relief chevron_right
9.4 Overall Score
4.4
starstarstarstarstar_half
(1,027)
company logo
#3 Community Tax chevron_right
8.8 Overall Score
4.7
starstarstarstarstar_half
(528)

Related Articles

What Experts Say About Getting a Loan to Pay Taxes

August 19, 2020

It’s tax preparation season: tax returns for 2019 are due on April 15. You might receive a refund after filing, bu...

Read More
How to Get Rolling on Tax Planning for 2020

July 10, 2020

Guest Post by Lee Reams As the end of 2019 approaches, it also means that the 2020 tax season is imminent. If your tax s...

Read More
IRS Debt Penalty Forgiveness in 2020: What Happens When Yo...

July 30, 2020

This article has been updated for 2020. You owe the IRS money and can't pay off your tax penalties. So what happens now?...

Read More