As taxpayers eagerly anticipate their annual windfall in the form of tax refunds, financial experts are cautioning against celebrating too soon. While the average tax refund reached nearly $3,200 last year, analysts warn that receiving a sizable IRS check may not be the optimal financial strategy.
Janet Holtzblatt, a senior fellow at the Tax Policy Center, acknowledges the universal allure of tax refunds, stating, “Everyone loves a tax refund, even me, though I know better.” The 2023 filing season saw over three-fifths of taxpayers receiving refunds, with the average amount steadily increasing. Notably, the peak was observed in 2021 at $3,300, propelled by pandemic-related credits.
However, financial experts argue that this upward trend in tax refunds might signal a misplaced financial strategy, particularly in a time of escalating household debt. Rather than viewing a large tax refund as a windfall, analysts suggest that taxpayers might be better served by adjusting their withholding to put that money to more strategic use.
Michelle Su, a CPA and MBT based in San Francisco, emphasizes that receiving substantial tax refunds indicates over-withholding, effectively providing the government with an interest-free loan. As consumers grapple with soaring borrowing rates and record-high debt balances, redirecting this money towards debt repayment or interest-earning savings may be a more prudent financial move.
To assist taxpayers in optimizing their financial strategy, experts provide practical tips for updating tax withholdings. The W-4 form, which determines withholding certification, can be adjusted throughout the year by submitting the updated form to employers. While making changes at the beginning of the year is ideal, adjustments can be made later, considering life changes during the course of the year.
However, experts caution against overlooking potential penalties for underpayment, particularly during significant life events like marriage, divorce, or the birth of a child. Filing status and tax brackets often change with these events, and failing to update withholdings could lead to IRS penalties.
Despite the initial appeal of a large tax refund, experts emphasize the importance of strategic financial planning to avoid unnecessary financial pitfalls and penalties. In an era of economic uncertainty, where every dollar matters, reassessing one’s approach to tax refunds may prove to be a pivotal step towards financial resilience and stability.
