The Cutting Edge: Big Tax Refund? You Might Want to Think Twice

Overpaying Uncle Sam is like giving him an interest-free loan

0408_w4Alert!

Alert!

Scientists have isolated the gene responsible for intaxification, a deadly virus sweeping the nation. Symptoms range from refund euphoria, acute spending, and severe headaches.

OK, there is no such ailment as “intaxification,” at least according to the American Medical Association, but there is such a thing as overpaying Uncle Sam. Though buxom tax returns can seem like a blessing, sly ol’ Sam is only returning your hard earned dollars, interest free!

Check out these tips to help you determine the correct number of federal withholdings:

Know the implications. Remember those lengthy forms you filled out when you started your job? One of them was the IRS W-4 form, which is used to help employers determine the amount of income tax to withhold from your paycheck. The more allowances you claim, the less income tax will be withheld from your paycheck. “Some people play it safe and say ‘I’m only going to choose one allowance’ so they get that refund,” says Jean T. Wells, certified public accountant and assistant professor at Howard University’s School of Business. “I had clients who would get a $10,000 refund and they would be giddy.” That $10,000 (or $883 a month) could’ve earned a return in a money market or savings account.

Paying too little could result in owing the government big bucks, and the government’s interest on what you owe compounds daily. The goal is to even out your refund at zero or somewhere close to it, Wells says. The IRS offers a comprehensive guide to help taxpayers determine their withholding.

Spread out your credit. Those who qualify for the earned income tax credit (EITC) aimed at assisting low-income taxpayers can spread their payments throughout the year with the advanced earned income tax credit. Let’s do the math: If you’re eligible for the maximum EITC of $5,500, that’s an extra $400 a month. Why wait for a lump sum when you can gain access to your money now? To find out if you’re eligible for the EITC or advance payments, visit IRS.gov.

Conduct a mid-year review. Oftentimes, life throws curve balls faster than El Duque in the 7th inning stretch. Having a baby, assuming guardianship over an elderly relative or child, buying a house, and divorce are some of the events that can impact the number of allowances you claim. For instance, if you just bought your first home or plan on buying one this year, you’ll be eligible for a $7,500 first-time homebuyer credit.

“If you estimate your overall tax liability to be less than that credit, you can set your withholdings to zero,” Wells says. Remember, a tax credit is money back in your pocket. The IRS provides a tax withholding calculator to help you figure out how many withholdings you should have.

A last piece of advice from Wells: “Getting a refund should not be a substitute for trying to save,” she says. “You should be disciplined enough [to put] $50 or $100 a week in a savings account where it can earn interest, instead of doing it the other way around and giving IRS money and getting 0% interest in getting it back.”

Renita Burns is the editorial assistant at BlackEnterprise.com.

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