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It's that time of year and we are having lots of conversations with our financial coaching clients and Financial Peace University class members about taxes.
Today let's stop by the 3 options you may be facing.
Owe - You Owe the IRS
If you owe the IRS money, don't panic. The key is to be proactive. Since this article is in February and you already know you are going to owe money, great job on getting your taxes done early! And if you haven't filed your tax return and you think you're going to owe...file your taxes immediately!
Please don't let April 15 (April 18 this year) come and go without them being filed. You can file without a payment...just file!
If you file without a payment, you will have until the end of May or the beginning of June before the IRS sends you a bill. That gives you time to save up the money. THIS SHOULD BECOME YOUR HIGHEST PRIORITY. Use the months between finding out that you owe and when you get the tax bill to save the money to pay your taxes and get them paid immediately.
If the amount is more than you are able to save, pay as much as you can as soon as you can. Interest and penalties accrue daily on the balance! The IRS is worse than student loans in terms of the amount of interest and fees assessed on balances. Be prepared to negotiate a payment plan until you can get it paid off. Pause your debt snowball and redirect all extra money to get your taxes paid as quickly as possible.
Keith and I typically owe federal, but get refunds from the states of Kansas and Missouri (we live in Kansas, my day job is in Missouri). By filing early, we receive the refunds from the state returns and use them to pay our federal taxes. The net result is typically around $100 in our favor. Which takes us to the next tax scenario...
No - You are Plus or Minus $500
You are plus or minus $500 in your total tax picture. Congratulations! You have successfully paid the right amount of taxes for the year. If you're getting back under $500 or owe under $500 between all of your tax returns (state, federal and local)...way to go! This is the ultimate goal and you nailed it.
The government is not getting an interest free loan from you all year and you were able to use all of your income on a monthly basis. Your budget has the most money possible and you are using all of your income for your household.
This is the sign of a fiscally savvy person who understands the long term value of having access to your own money. Again...job well done.
And now the controversial one...drum roll please!
Noooooo!!!! You Have A Large Tax Refund
You are getting back a refund of over $500...not good. You have just given the IRS an interest free loan on your hard earned money. You have removed a significant chunk of money out of your monthly budget and are operating at a fiscal disadvantage.
Below are 3 reasons people often give for wanting a large tax refund and why you should rethink them.
1. "I can use it to pay down debt." If you had the money in your account each month, you could do the same thing and would actually end up paying off your debt faster since you would not accrue as much interest on the loan balances. This is especially true for student loans. See my previous post about how to pay down student loans.
Ultimately, paying off debt is much more effective when it's done consistently and not in spurts. Click on the button below for a list of 4 ways to eliminate debt using your tax return.
2. "It's a built-in savings account." Maybe...at zero percent interest. Even banks do better than that. If you're going to save the money, just save it as it comes into your account each month. Set up an allotment to have it sent directly to your savings account or transfer it after it hits your account. Either way, earn more than zero percent in your money.
3. "I can use it to make large purchases or pay for a vacation." Again, having access to your money monthly is a much better way of saving for large purchases. You control when you use it and can therefore take better advantage of sales and discounts throughout the year instead of waiting until Uncle Sam gets around to sending your interest free loan repayment.
If you're curious about how much to save, simply divide the amount of this year's tax return by 12 and that will tell you approximately how much extra money you have access to each month. Check with your HR department on how to adjust your tax withholding accordingly.
In Matthew 22:21 Jesus said "render to Caesar the things that are Caesar's; and to God the things that are God's." He did not say you needed to give your money to Caesar early and let him keep it interest free all year.
Christ-centered financial wellness is all about being aware and proactive. Paying the appropriate amount in taxes owed in a timely manner is a huge part of achieving it. I pray this article gets you one step closer to it.
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Until next week...be well...be encouraged.
