A large tax refund may feel like
free money. It isn't.
This year about 7 out of 10
taxpayers will get some money back from Uncle Sam.
Early bird filers who submitted
their returns when tax season opened Jan. 29 may get their money in the coming
weeks.
The IRS expects to receive nearly
155 million tax returns this season.
Many tax refund recipients plan
to put that money to work.
About a third of taxpayers
getting a refund expect to save or invest the money, while nearly 3 in 10 will
pay down debt, according to Bankrate.com.
Here's the bad news: If the IRS
sends you a huge check this spring, it means you've likely overpaid on taxes
throughout the year.
"A large refund from the IRS
may seem like an advantage, but it isn't the best or most effective use of your
cash flow," said Tim Steffen, director advanced planning at Robert W.
Baird & Co.
"You're basically giving the
IRS an interest-free loan," he said.
Know your withholding
If you're an employee, your
employer gave you a Form
W-4 when you were hired, which you can adjust to make sure the right
amount of income tax is withheld from your paycheck.
On the form, you'll make note of
your spouse, your dependents and your filing status; these are your
"personal allowances." The more allowances you have, the less tax
will be withheld.
"Some people read the form
and think, 'I'm married and have three kids,'" said Cari Weston, director
of tax practice and ethics at the American Institute of CPAs. "They end up
with five allowances and owe substantial taxes at the end of the year."
To make things more complicated,
the IRS is making internal tweaks to reflect the changes from the Tax Cuts and
Jobs Act. The agency released new
withholding tables, which take effect this year.
The IRS is also working on
a calculator and
a new Form W-4 to help you
figure out the correct withholding based on the new tax code.
Tax uncertainty
Use your 2017 tax return to get
an idea of how much you ought to withhold this year.
To ensure that you avoid a penalty for underpayment of
estimated taxes, you should aim to pay in 2018 at least 100 percent of
the prior year's liability, said Jeffrey Levine, CEO and director of financial
planning at BluePrint Wealth Alliance in Garden City, New York.
This doesn't mean that you won't
owe in April 2019. Rather, it means the IRS won't charge you the penalty and
interest next year for coming up short on your taxes.
"If you see your tax rate
increase substantially, you might owe a larger amount over the
withholding," said Levine. "Aim for that 100 percent: It's a better
method of avoiding the underpayment penalty."
Tailor your tax load
Here's how to evaluate your
withholding and make sure it's just right for you.
Review your
W-4: Striking a balance for withholding will be based on your salary,
your spouse's earnings and the tax bracket you're in.We're in a year
with many changes to the withholding table, plus a reduction in federal income
tax rates. You may be taking home a slightly larger paycheck, but you should
make sure you aren't withholding
too few taxes.
Talk to your
accountant: Filers who withheld fewer taxes because they itemized on
their returns will need to revisit their withholding. That's because the
new law does away with a lot of itemized
deductions and places a $10,000 cap on state
and local tax deductions.
Fewer filers are
expected to itemize in 2018 because the new tax law has doubled the standard
deduction. Under the previous law, about 49 million taxpayers — roughly 3 in 10
individuals — filed itemized returns, according to the Urban-Brookings
Tax Policy Center.
If you fall into
that category, you may need to update your allowances in 2018 to ensure you're
withholding the right amount of tax.
Calculating your
withholding is more complicated if you have multiple sources of income:
distributions from retirement accounts or cash from a rental property. You'll
need to make estimated quarterly tax payments in those cases, Steffen said.
"Work with a CPA to do a projection and figure out what your tax liability
will be at the end of the year," he said. "In a perfect scenario,
you'll have a balance due when you file your return, but not one that's large
enough to create a penalty."
Avoid tax
arbitrage: If you withhold less in taxes because you have bigger
plans with your paycheck, bear in mind that you'll owe Uncle Sam next
year. Don't gamble your cash.
"Some people do foolish things: 'If I invest the money and make 7
percent this year, and I beat the IRS' penalty, then I'm ahead,'"
said Levine. "If you've deliberately underpaid, the money should go
someplace safe because this is a really short time horizon," he said.