Tax Refunds: Good Or Bad?
A Twitter listener asks how many exemptions to take in order to still receive a tax refund. Dave explains how exemptions work and why you don't want a tax refund.
QUESTION: A Twitter listener asks how many exemptions to take in order to still receive a tax refund. Dave explains how exemptions work and why you don’t want a tax refund.
ANSWER: Your goal is not to get a tax refund. Also, claiming the proper number of exemptions doesn’t guarantee that you’ll pay the right amount in taxes. The IRS tables don’t work all the time, which is a shocker.
There are two ways to determine the proper amount of withholding. The most thorough way is to do a mock tax return. If you write down what you make and what your deductions are, you can figure out the amount of taxes you should be paying and make sure that amount is being withheld from your check. If you determine you’ll have to pay $12,000 in taxes, then you want $1,000 a month withheld from your check. Then you claim enough exemptions to get that withheld. Assuming you put all the right stuff in the mock tax return, that will cause you to hit it pretty close.
Another way to do it that might be a lot easier and almost as accurate is to look at your life situation and see if it has changed. A big change would be something like having a child, or a child of yours is no longer an exemption, or you bought a house or had a bunch of extra charitable giving, or something like that. If you had no big changes last year and got a refund, then change your W4 exactly enough and claim enough exemptions to do away with the refund. As an example, if you got a $3,000 refund each of the last three years and nothing has changed, then change your W4 and claim more exemptions to increase your take-home pay by $250 a month, which equals $3,000 a year.
Take the amount of your refund and divide it by 12 to make sure you bring home that much more money each month. I have a daughter in her 20s who is single with no children and doesn’t own a home, and she claims several exemptions. Doing that came within about $50 of her getting a refund. You don’t want to get a refund.
Why don’t you want to get a refund? All that means is that you’ve been overpaying all year, so you’ve got a savings account with the IRS at zero percent! If you got a $3,000 refund, Santa Claus didn’t send that to you. That means you paid in $250 too much each month. Stop doing that, because you need that money to get out of debt.