Friday, April 22, 2005

Review your withholding - A Tax Refund is an Interest Free Loan to the IRS

Are you celebrating your refund? Just bear in mind that what you got back in the mail is your money. The government isn't giving you its money - it is simply returning to you money that you overpaid. So each time you got paid, you gave the government too much money. Instead of going into your bank account every 2 weeks, it went into the governments bank account. They have been using this extra money you gave them all through the year. And when they finally give YOU back YOUR money, they don't even have the courtesy to pay you interest for using your money all year.

Now I know a lot of people see their refund as found money. And in a sense it is, it is your money finding you again. But from a cashflow perspective, wouldn't it be nice if more of your money stayed with you throughout the year. Ideally, withholding should be a zero sum game - come April 15, you owe nothing and are owed nothing.

If you are a W-2 employee, this situation can simply be changed by taking charge of how much is withheld from each paycheck. Depending on the amount of deductions you have, you can adjust your withholding. The IRS has Publication 919 - "How Do I Adjust my Tax withholding" which will walk you through the proper withholding for you. You fill out a worksheet and your target withholding number appears. Go to your Human Resources office, fill out a new Form W-4, and the adjustment will be made. The IRS encourages this to be done. The stated purpose of the Form W-4 is:

"Purpose. Complete Form W-4 so that your
employer can withhold the correct federal income
tax from your pay. Because your tax situation may
change, you may want to refigure your withholding
each year."

The last time you filled out a W-4 was probably when you were hired. If you have gotten married, had a child, or purchased a home since then, chances are your withholding is way off. Do yourself a favor - Read Publication 919 - "How Do I Adjust my Tax withholding" and download Form W-4.

And for those of you who see your refund as forced savings, here is an idea: Set up a direct debit from your checking account to a savings account in the exact amount of extra money you are getting each paycheck by adjusting your withholding. Come April 15 next year, you will have the same pot of money, plus interest, and can celebrate your "refund" then.

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