A federal tax refund is money given by the IRS to a taxpayer to return any amount the taxpayer overpaid in their income taxes during the year. The IRS requires employers to provide reports four times a year detailing who they employ and how much they pay them. The agency compares these records with the tax payments made by a specific employee when the employee files their yearly return. If both documents show that the employee paid more than they needed to, the IRS issues a refund.
What Do The Experts Say about Refunds?
Financial experts state that you should strive to never get a refund. Television host and author Suze Orman suggests that it's better to not get a tax refund, indicating that the tax overpayments that lead to refunds are like loaning your money for free to the government without getting any interest. Similarly, Dave Ramsey is against tax refunds.
The reason for these statements is the fact that it's better to not overpay the IRS, but instead to keep as much of your earnings as you can to live off during the year, invest or save. To these experts, refunds per-se are not the problem, but rather what they indicate: overpayment and inaccessibility to earned money. Overpaid taxes are returned once a year by the IRS and do not accrue interest during the period of time the IRS holds them. This means that the taxpayer loses out on the ability to pay off debt or invest those funds, both of which increase their overall wealth.
Should I File for a Refund?
If you are legally entitled to a refund, you should request one, no matter how large or small it is. "Legal entitlement" depends on whether you overpaid income taxes to the Internal Revenue Service (IRS) over the past work year. You may have overpaid taxes because you did not earn as much as you anticipated or had credits or deductions which reduced your obligation. If you have documentation of your having paid taxes and any credits or deductions you claim, you are legally entitled to a refund.
The main reason why you should request a refund is because the IRS cannot give any money owed to you to someone else. This means that if you do not claim your refund it sits in a bank account doing nothing. Each year the IRS puts millions, if not billions, of dollars of unclaimed refunds into a non-interest bearing account.
Despite their not supporting refunds, very few financial experts urge you to not file for a refund if you are owed one. This is because you can then use that money.
Does the Size of the Refund Matter?
Does your tax return show that you're entitled to a large refund? Refunds are money owed to you, so go claim it. Because the IRS has records of your payment, it is unlikely to question the size of your refund. In fact, after the 2008 housing crisis, many taxpayers received quite sizeable refunds.
The size of your refund is irrelevant. It's your supporting documentation that is important. If the IRS should question the amount of your refund you can rely on your documentation to show your entitlement.
Will I Be Audited?
You might hear talk that a big refund raises a red flag for the IRS. This is untrue. In fact, audits are rare. According to Tax Debt Help, in 2009, approximately one percent of all tax returns were audited. The majority of those audits occurred on taxpayers with incomes of more than $10,000,000.
Unless you engage in complex or convoluted calculations or have an extremely large income, it's unlikely that you will be audited. Don't let that stop you from filing a return, especially if you're entitled to a refund.
How Do I Get A Refund?
To receive a refund you must file a return. The IRS sets a deadline for returns, which usually falls in the middle of April. If you do not file a return you cannot receive a refund.
You can file a return for past years to receive a refund owed for the corresponding year (remember, that money is just sitting in an account). There is no penalty for recovering an overdue refund, but there is a penalty for filing your taxes late. You should always file a tax return by the deadline to avoid these penalties. There is no link between filing a tax return late to acquire a refund and an audit.
You can also amend a previously filed return if your calculations were incorrect and you believe you are entitled to a refund. There is no penalty for amending a return, provided that the original was timely filed.
What Should I Do With My Refund?
How you spend your refund is up to you. The American Association of Retired Persons (AARP) advises consumers to use their refunds to pay down debt. Similarly, Bank Rate promotes using a refund to plan for the future.