So you've been anxiously waiting for your refund check. And so maybe you're checking your account
every day, or you're checking your mail waiting for that check from the IRS, or that payment from
the IRS. Because you know, you're about to get thousands of dollars. And yeah sure, it could be
really exciting but I'm going to tell you in this video why it might not be such a great thing to
get a big refund. And this applies to most people, not all people, and I'll explain that as well.
In this video I'm going to talk about how a refund works.
Why it might not be a good idea to have a big tax refund. I'm going to bust some
thoughts or myths regarding refunds and what people think and, and how they think, and
why it's kind of flawed logic. And also I'm going to talk about refundable credits, which is
something that is important to discern between whether or not a refund is actually good or bad.
As I said before, a tax refund is not all bad okay. There are some situations where people
will get a large tax refund, when their tax liability wasn't that great. So I'll go over
that a little later in this video. And also I'll go over how you can fix your refund situation
if you've been consistently getting large refunds in the past or if you've been owing a lot of taxes
in the past, I'll show you how to handle that alright. But first let's talk about how a
refund works. And in order to do that, let's jump over to the computer so I can show you on there.
So here you see an example with a payroll, and a salary amount, and taxes withheld. So as you know,
if you work at a W-2 job, you have your federal and state taxes withheld from your paycheck
every every time you get paid. And what happens there is that your employer takes your taxes
from your paycheck and pays the government for you. So that's what's happening there okay. So
we're going to just talk about federal taxes. State taxes work essentially the same way.
But for this example I'm just going to make everything very simple, we're not going to
use actual tax rates or anything. I'm just going to use a straight 20% just to make things simple.
So as you can see here, this person has an annual salary of $100,000.
And let's say he had $20,000 of taxes withheld from that and paid to the IRS, from his employer.
So what happens when he files his tax return
at the beginning of the following year? Let's see. So he's going to report his salary of $100,000.
He's going to take a standard deduction of $24,000. So let's say this person is married and
his wife doesn't work okay. So they're married with one income, that's why they get a standard
deduction of $24,000. So that brings his total income to $76,000 you know instead of $100,000.
Now you can already see 20% of $76,000 is going to be much less than $100,000.
So according to the tax return, this person owes $15,200 in taxes but the his employer withheld
$20,000. So what happens to the extra money? It gets refunded to the person of $4,800 okay. So
one thing to keep in mind here is that refunds are not "free money". They are your money that
you gave to the government and the government gave back to you alright. Okay so now that you
know how a refund works, let's talk about some of the justifications that people use
to basically justify why it's a good idea to get a large refund. So the first one I hear a
lot is that it's it's kind of like a "bonus", like you're getting a bonus for yourself
at the beginning of the following year. And you know, that's not entirely true because this is
again, your money that you gave to somebody and then they just gave it back to you.
So no, that's not like a bonus. Another justification here is that it ensures that
"I save" money. If I got that money back every month or if I got that extra money every month,
I probably would spend it anyway. So this ensures that I save the money okay. Well
let me ask you this, once you get the money back as a refund what the hell do you do with the money
okay? Do you spend it on something crazy, or do you put it in a savings account,
or what do you do with the money? I understand that sometimes people need more extreme measures
to help them save money. You know, like kind of out of sight out of mind thing. But there are
much better ways to do that because if you're if you're using the IRS to help you save money,
you're not making any money on that savings. So one thing you can do is have your employer
direct deposit the excess money into a separate savings account okay. Because if you have direct
deposit, you can actually have that money, your income, your pay deposited into multiple accounts.
So that's one option. Another option is just to have it all direct deposited into your main
checking account and have automatic transfers out to a brokerage account, or savings account,
or whatever it is automatically, every month. So you don't even have to think about it. Those
are some much better options because you would actually make some money. Even a savings account,
you know like some banks, like Ally Bank, you at least make some money
rather than making zero money, giving it to the IRS. And the last thing I hear people say a lot
is that they like to buy themselves a nice treat with their with their tax refund money. You know,
they'll go buy something new and fancy, or some toy that they wanted for a while.
And you know, you've just got to ask yourself is that really the best use of your money.
You know, and it's not it's not my place to say that that's a waste of money
because people have different values from each other and some people might really value
enjoyment or joy from from these things that they buy. So it's just a scenario to ask,
is that really worth your money? And again if it is, it's still better to put it in your
own savings account or your own brokerage account and have it earn money while you save up for that
thing that you're looking for. Okay so now that we talked about some justifications that people have
I'm going to talk about one scenario where a big refund is a good thing for these people okay.
So let's jump back onto the computer. Alright so I'm going to talk about what's called a refundable
credit. A refundable credit is a credit that you get back as a refund even if it's greater than
your tax liability. And this usually applies for more lower income people or lower to middle income
people with a lot of kids or with children okay. So here in this very simple example,
we have somebody making a $15,000 salary okay. And let's say their their tax liability is $1,500 or
10%. Now let's say they have one child and they qualify for this earned income credit okay. Now
as you can see the earned income credit is $3,500. Their tax liability is only $1,500.
So because the earned income credit is a refundable credit,
this person will still set a refund of $2,000, even though their tax liability was only $1,500.
So that is what a refundable credit is. And if you're in this situation you know, where you
you have a child tax credit, and you have an earned income credit, or the American
opportunity credit, those are three of the main refundable credits, then you don't have to feel
like you need to adjust anything on your W-2 or on your W-4. You know it's not that big of a deal
as those people who are making more money and receiving a huge, huge refund okay. So
this is basically a refundable credit in a nutshell. So most tax credits are non-refundable.
Which means that it will take your tax liability down to zero but then it won't give you a refund
okay. It will carry any excess credit left over to the following year. So what do I mean
by that? So let's change this to a non-refundable credit. So now you have a tax liability of $1,500,
a non-refundable credit of $3,500. That's going to give you a refund of $0 because you know,
the credit is greater than the tax liability so it eats away the entire tax liability okay.
That means there is a $2,000 carryover to the following year. And in the following year
you know, if your tax liability increases then the credit that you carried over will you know,
start to eat up that tax liability for the next year and so on and so forth. And it will keep
carrying forward until it's used up. So let's say you're not in a refundable credit situation,
and let's say you do have either a huge refund at the end of the year, or you are owing a lot
of taxes at the end of the year. So what can you really do about this? The the main thing you can
do is to adjust your W-4 with your employer. Now there used to be a version of the W-4 that
would just have you put in the number between 0 and 99, there's some calculation that you can
you can go through to come up with the number. But it's just like putting in this number that
kind of determines what your tax withholding is. And in my opinion, it wasn't that great of
a system because it's a lot of, it could be off, you know there could be some guesswork there.
So there's a new W-4, which I think is much better, and it uses your actual income numbers,
and your actual deductions that you expect, and it calculates your withholdings that way. That's
the one, one of the main things you can do to adjust your refund or your taxes due at the end
of the year is to adjust your W-4 with your employer. Another thing you can do is use the
IRS tax withholding estimator tool. That way you can see mid-year what's going to happen
at the end of the year when you file your taxes. It's a good way to kind of predict
you know, whether or not you're going to get a large refund, or you're going to owe a lot.
And that's going to help you determine how much more withholding or how much less withholding
you should be taking from your employer as of the middle of the year okay. Now if you use
that tool, and you go that route, just be sure to actually change your withholding back at the
beginning of the following year to make sure it's consistent for the entire year alright.
So that's all I've got for today. Thanks for joining me. If you're new here, I'd really
appreciate it if you'd subscribe to my channel and stay up to date with everything business and tax
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have and I'll do my best to get to them. Alright so take care for now and I'll see you next time.