Imagine looking over your net worth statement, to find an asset called “Interest Free Loan to U.S. Government.” As someone who tries to get the most out of every dollar, what thoughts come to you? Do you feel like this is the best place for your money?
If I told you that around 82% of American tax payers who file early are making this interest free loan each year to the U.S. Government, would you believe me? Even worse, that this average interest free loan is $2,869.
The purpose of this post is to explain what a tax refund is, how to minimize your tax refund, helping you to decide the best use for your tax refund this year.
Why do you get a Tax Refund?
If you’re expecting to get a tax refund, it’s because you overpaid your taxes throughout the year.
The tax system is set up, so that instead of you having to write one big check at the end of the year, income taxes are withheld from each paycheck. The amount of taxes withheld from each paycheck is based on how many exemptions you filed for on your W-4.
On the form, you mark the amount of exemptions you claim each year. The more exemptions you claim, the less tax you pay on each paycheck. Meaning, each paycheck will be higher.
If you decide to file for fewer exemptions, the more money will be taken out of each paycheck for taxes. This results in your paycheck being reduced.
The goal is to file for just the right amount of exemptions on your W-4, as to minimize the amount you either owe or pay.
Tax Withholding Estimator| Adjusting your W-4
There are many variables as to how many exemptions you can claim. So there is no general rule of thumb as to how many exemption you should file for.
The best way to figure out your exemptions is to use the IRS Tax Withholding Estimator.
It only takes 15-20 minutes to fill out and it will give you a very accurate estimate as to the amount of exemptions you need to file.
What to do if you get a Tax Refund for 2010?
If you do get a tax refund this year, put it too good use. It’s not free money. It’s money that’s rightfully yours, being returned to you.
The best use of a tax refund is to pay off any high interest debt. The next choice depends on where you’re at in your financial life. Wise uses include:
- Starting an emergency fund
- Paying off any low interest debt
- Using the cash to pay monthly expenses, while you max out your 401(k) employer match
- Starting a Roth IRA
- Important goals
Make it a habit to review your W-4, by using the IRS’s tax withholding estimator, twice a year. Once late in the year, say November, and once just after you file your taxes.
Knowing that the average tax rebate is $2,869, this small exercise can increase your cash flow on average $239 a month.