The income tax system is a pay-as-you-go tax system, which means that you must pay income tax as you earn or receive your income during the year. You can do this either through withholding or by making estimated tax payments.
The Internal Revenue Service has an online Tax Withholding Estimator to help you estimate the federal income tax you want your employer to withhold from your paycheck.
Tax refunds are an overpayment of your taxes; therefore, you’re just getting money back that you never owed the IRS in the first place. Refunds mean you’re taking home less money in each paycheck.
An ideal situation for some is to owe or be as close to zero as possible when their taxes are filed. Some will further argue that you should pay just enough income tax so you do not get a refund.
If you have just earned income from an employer, tools like the IRS Tax Withholding Estimator will give you an excellent tool to join the ranks of those who cheer for not getting a refund. To them, tax refunds are an overpayment; you’re just getting money back that you never owed the IRS in the first place.
If you have someone prepare your taxes, they can offer advice, but that is a professional opinion. There is no certainty until after the IRS reviews your taxes.
I would argue that you should consider an overpayment tactic for your taxes.
Here is why.
Getting a refund means that when you finally submit your tax return, you do not have to complicate your life further by writing a check or using a credit card to the IRS if you owe more money than paid.
A cushion of a few hundred or thousand dollars in your prepaid taxes to the IRS can simplify your life.
Your calculation of your taxes due may be off. Sometimes, the IRS reviews your taxes and their math discovers you owe additional taxes. Wouldn’t having some of the refund buffer come to the rescue be nice?
Remember, even though you use tools like the Tax Withholding Estimator, it may not account for all the unknown adjustments to your life during the current tax year, such as promotions, bonuses, or taxable income from investments.
If your taxable income for the year elevates you to a higher bracket, you do not get an email announcement.
Taxpayers who don’t pay their entire tax bill by the filing deadline are subject to a 7% underpayment interest fee, among other penalties.
This penalty only applies to those who owe $1,000 or more in unpaid taxes. If you’re subject to this charge, you’ll receive an IRS notice in the mail.
In addition to the underpayment interest charge, you could face a late-payment penalty, sometimes called the failure-to-pay penalty. This is an additional charge of 0.5% of any unpaid taxes for each month or partial month the tax goes unpaid, capped at 25% of your tax bill.
The bottom line is that building an overpayment buffer into your tax forecast simplifies your life. Then you can get advice on what to do with your refund.
