Reduce your refund, but not by too much
February 22nd, 2006 | by mbhunter |I, like many Americans, will get a refund from Uncle Sam for my 2005 Federal Income Taxes this year. And, as TurboTax has reminded me the previous few years, this is really an interest-free loan to Uncle Sam.
Flexo has a post on the tax refund deals that really aren’t great deals — they’re VERY high interest loans, actually, and he recommends that people watch out for them. Most of this post contrasts the effects of letting the government hold your money for a while so that you don’t spend it vs. you having access to it earlier, and perhaps spending it unwisely.
Additionally, for those who want to loan as little of their money to the government as they can, there are other rules to worry about. You can’t withhold too much, or you’ll be hit with penalties. The IRS’ web site has information on the rules, and also has a withholding calculator. In order to cut your refund to the bare bones if you’re interested in doing that, you’ll need to do some research and figure out the number of exemptions you’ll need to minimize your refund while at the same time conforming to the IRS’ rules.
I prefer baby steps, just so I don’t get caught paying a penalty. That for me is worse than a big refund check.
UPDATE: Flexo updated his post with some more information about figuring out how much you’d be penalized if you underpaid.
3 Responses to “Reduce your refund, but not by too much”
By Lori on Feb 22, 2006 | Reply
Ok so I was reading what you had to say about owing the gov’t a penalty if you don’t have enough taxes taken out of your paycheck during the year. Can you expound on this. My husband and I were thinking about setting up his paychecks at work so that no federal taxes come out of them, and then just put the amount that would have come out of them each week in our HSBC account and let it earn interest. This year we actually got more money back from our tax return than what we paid in (because of our student loan interest and because of the child tax credit) so we will probably get a refund next year even if we have no taxes taken out. So if we set it up so no federal taxes come out of his check will we really have to pay penalities, or is that just for self employed people? Thanks
By FMF on Feb 22, 2006 | Reply
I agree. You don’t want to let them use your money — but it’s worse to have to pay a penalty.
By mbhunter on Feb 23, 2006 | Reply
Thanks for the comments FMF and Lori!
Lori, you can do that but you’ll be paying 6% to 7% penalty on the money you should have been paying to Uncle Sam. Isn’t it great — you can overpay and he pays you back without interest, but if you underpay, you owe him interest! There are some exceptions, but I wouldn’t try withholding nothing!
The government does an excellent job of collecting its payroll taxes — better than just about any other kind of tax. The government came up with withholding because it was a surefire way to get their “fair” share — before you ever had a chance to spend it away!
The relevant document is IRS Publication 505. It applies to employees as well as the self-employed.