Why You Want The LOWEST Income Tax Refund Possible
Doug Smith

Defined Tag: Income Tax Refund.

An income tax refund is a return of the money you have overpaid on your federal taxes. The process of filling out a tax return determines the refund amount. If American taxpayers have paid more taxes to the government than their tax liability, then they are owed the difference as a refund. If they paid less tax throughout the year than their tax liability, then they must pay the difference. Therefore a big tax refund is a good thing, right?

That is not necessarily true. The U.S. Internal Revenue Service (IRS) requires federal income taxes to be automatically withheld from each American taxpayer's paycheck. The amount withheld from each check is determined by filling out a W-4 Form at the beginning of each calendar year. The taxpayer's W-4 Form tells the employer how much to deduct from each paycheck. Note that the W-4 only provides an estimate of what your yearly taxes will be. The deducted taxes go to directly to the government.

At the end of the year, you get to go through the tax return process to modify the amount paid during the previous year to determine if more taxes need to be paid, or if you paid too much and deserve a refund.

After the end of each calendar year, the employer issues a Form W-2 to each taxed employee. The form lists the employee's total income and how much federal tax was withheld over the year, among other things. Each employee that paid income taxes is responsible for determining his or her previous year's tax liability or refund amount. This is done using the W-2 forms, financial records, and the 1040 IRS tax calculation form.

The tax preparation process can be complex and tedious, which is why many tax-paying citizens utilize a Certified Public Accountant (CPA), a tax attorney, or tax software. Sometimes individual returns are simple enough that an individual can calculate the forms manually.

The tax return process begins by determining the total amount of taxable income earned during the previous year. This can include hourly or salary wages, tips, interest income, home business income, investment income, and other sources. Most agencies will supply you (and the IRS!) with a Form 1099 listing the income from each source.

Then you must determine your tax liability, which is the amount of taxes you should have paid during the previous year. Remember that the taxes deducted last year based on your W-4 form were only an estimate. The tax return process allows you to refine that value to determine if you paid too much or not enough.

You will receive a W-2 form from each employer that withheld federal taxes from your paycheck. The total amount of income listed on all the W-2 forms is your taxable income. The total amount of tax paid on all the W-2 forms is the amount of IRS tax paid.

Subtracting allowable deductions from your taxable income can decrease your taxable income, and therefore your overall tax bill. Tax deductions are typically living and employment expenses to which you are entitled, or for which your employer does not reimburse you. Examples of allowable deductions include home mortgage interest payments, medical bills, costs for professional training classes, and work-related travel mileage. Read the instructions for Form 1040, and the related Schedule A (Itemized Deductions).

You are allowed one large deduction for yourself, or for your family (depending on your married status and whether you are filing singly or jointly). This called the standard deduction. If you go through the process of calculating every deduction, and the allowed amount is larger than the standard deduction, then you can use the itemized deduction amount. The deduction amount is subtracted from your taxable income amount.

The IRS publishes new tax tables each year. You find the taxable income range (called a tax bracket) on the tables that contains your modified taxable income, and your corresponding tax payment is shown. If you have already paid more than the amount shown, you have overpaid and the IRS issues you a tax rebate check for the difference. If you paid less than the amount shown, you must pay the difference to the IRS.

NOW: Why would you want that tax rebate to be small? Isn't that free money?

Absolutely not. Many taxpaying citizens think that a big tax rebate is "found money." It is not. It is money that YOU have been paying to the government for the past 12 months! If you have a big rebate amount, then you have been overpaying your taxes, and giving the government interest-free use of your money during the past year. While that is generous of you, it isn't very smart.

Look at it this way. Let's say your friend Bob asks you for a loan of $100 per month for 12 months, or $1,200 total. He tells you he only really needs $20 per month, but you should give him $100 per month just to be safe.

You like Bob, so you agree to the loan, and decide not to charge him interest. However, he secretly takes the other $80 each month and invests it, earning hundreds of dollars of interest without your knowledge. At the end of the year, Bob pays you back the $1,200 you loaned him. Later, you find out that he secretly invested the other $80 per month and made a big profit. You probably don't like Bob very much now, do you?

In the above example, you are the taxpayer, and Bob represents the government. Just as you would not allow Bob to keep, invest, and profit from your money each month, neither should you let the government. If you get a tax rebate check of $2,400, that means you overpaid by $2,400, and could have been putting $200 extra per month in your pocket last year! Instead, you put it in the IRS's pocket.

If you have special circumstances that allow you to claim extra deductions, take them. These might include extra medical expenses, or real estate transactions. Take all the deductions for which you are legally entitled. However, most taxpayers have a similar tax liability from year to year, and this article addresses those circumstances.

If your rebate is close to zero, that means you are paying the correct amount of taxes each year, and are taking home a bigger paycheck because less tax is being subtracted from each one. If you overpaid your taxes this year, modify next year's W-4 Form so that less tax is deducted from each check.

When your tax rebate or liability is close to zero, that means you are paying the correct amount of taxes during the year. It also means you are maximizing your take-home pay. Why would you voluntarily take a $200 per month (or more) pay cut? You wouldn't, and that is why you want the lowest income tax refund possible.

Copyright 2010 by Doug Smith.  All Rights Reserved Worldwide.  Unauthorized Duplication Prohibited.  Not Intended to be Professional Advice. Consult Your Own Financial Professional Before Taking Any Action or Advice.