All right, tax season is over, so now’s the time to learn a bit how to do it right the next time around. First, a brief history lesson. When the income tax was introduced to America in 1913, relatively few people actually paid the tax until the time when America entered World War 2. Up until that point, the tax was a “pay as you go” system, with those affected by the tax paying quarterly every year. Once America entered World War 2, with a dramatic increase in spending for the war by the federal government, taxes were raised, and with them came the concept of withholding: having money deducted automatically from your paycheck throughout the year — a system that has been in place ever since.
Nowadays, April 15 has a great deal of notoriety as “tax day,” or the deadline for most taxpayers to file an income tax return. This annual tradition often involved getting a great deal of money back from the federal government — money that a taxpayer had gradually overpaid throughout the year. I hear some people brag about how large their returns might have been, totaling in thousands of dollars returned to them after filing. There are a few reasons why this isn’t actually a good thing.
- Interest-free lending: When you allow the government to withhold your income they hold it interest-free. If you placed money in a savings account, on the other hand, you would get at least a tiny bit of interest on that money (less than 1% these days, but money nonetheless).
- Money when you need it: Some people think of withholding extra money as a way of forced savings. Here’s a better idea: have the money automatically transferred to a savings account. If your car needs a new transmission, you might not have until April 15 to come up with the money. Better to have that cash available (and earning interest) than to have to wait for Uncle Sam to give it back.
- Stealing your refund: A new kind of identity theft has surfaced recently. Criminals armed with your personal information apply for a refund as if they’re you, take your money and run. This leaves you in a difficult spot with the federal government, fighting to get your own money back. This appeal process can take up to two years, which can be very troubling if you were counting on a tax refund to pay for something important. It’s better to keep that money on hand where you can get it.
So what do you do now? Check with your employer and adjust your W2 withholding allowance if you received a substantial refund. If you received more than $1200 this year, you could take home $100 more every month without owing any extra on April 15. This may take a shift in thinking, but receiving a tax refund of $0 could actually be a good thing! Just remember to channel this “found money” into something like a savings account, something that can help you out all year long, not just on April 15.