“I always look forward to getting a nice big tax refund every year.” I don’t know how many times I have heard that, but it always amazes me that people say it -- and believe it is a good thing. There are a few situations which will result in people legitimately getting a refund of some of their withholding, but to expect, or even plan to get a sizeable refund every year is not good planning.
Let’s explore how the income tax withholding process came about. It was probably one of the most ingenious and, at the same time, sinister things the federal government ever did. Franklin Roosevelt had a theory that he could spend the country out of the Great Depression. The problem was the government didn’t have any money to spend. After hitting on the great idea of creating a tax on income, Roosevelt needed a way to be sure the money came into the federal coffers on a regular basis. The answer was to take the money from every wage earner every payday before he ever saw it.
The payroll withholding process allows the government to take money from every working citizen a little at a time, making the income tax easier to bear and more certain to be collected. This is good for government, but not all good for the citizens. Certainly, paying our income taxes a little at a time throughout the year is not as difficult or onerous as having to write a big check every April 15. But the downside of withholding is that we often don’t realize just how much we are paying or whether the amount is appropriate to our circumstances.
The federal income tax withholding tables are designed to take the correct amount from each paycheck to cover the expected tax liability for that individual in that tax year. The tables are complex because there are so many variables. Besides considering the amount earned, the tables have to take into account how the pay is distributed: weekly, bi-weekly, semi-monthly, etc. They allow for marital status and dependent exemptions as well. By selecting the correct categories on the W-4 form, an employee tells the payroll department how much tax to withhold each payday. In theory, the total withholding during the year should equal the amount of tax owed.
What all this means is that the person who is thrilled to get a tax refund in April is only getting back the excess tax paid throughout the year. At best, this might be thought of as an enforced savings program. While saving is generally a good thing, one should try to get a return of some kind for the investment. Although not very substantial right now, savings accounts pay interest to savers allowing their money to grow. Mutual fund money market accounts sometimes pay a little more than straight savings, and market type investments can pay quite a bit more. (They can also lose money in down markets.) The federal government pays nothing to hold excess tax collections for the year. This is a lousy investment for the tax payer.
There is another downside to letting the government use our money all year for free. In America today, there are few families who don’t have at least some consumer debt. The interest rates being charged by banks and stores for their credit are sometimes as high as thirty percent. Every withheld tax dollar that could have paid down debt costs the tax payer his debt interest rate.
If you want an eye-opening exercise, try this. In one column list all the consumer debt you have: mortgage, credit cards, store accounts, vehicle loans, etc. In the second column, list the interest rate you are paying for each item, then multiply the dollar amount of the balance times the interest rate. Write that number in the third column. Total the third column and divide it by the sum of the items in the first column. This is your average debt interest rate. Multiply your tax refund times your debt interest rate to see how much excess withholding costs you. Ouch?
The Bible instructs Christians to pay taxes to whom taxes are due. Fine. Scripture also teaches that we are to be faithful stewards of the resources we have been given. Leaving large amounts of money in the hands of Uncle Sam all year instead of using that money wisely in our own ways is not good stewardship. If you get a large tax refund every year, you should adjust your W-4 so that you come out as close to even as possible on April 15. This will give you the opportunity to make the most of every dollar you earn.
No comments:
Post a Comment