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Finance Friday – Is a large tax refund really a good thing?

May 10, 2023

Or, why is getting a large refund maybe not a good idea?

Many people think that if they get a large tax refund they’ve “won” on their tax return.

Whether you get a refund or owe tax when you file your return is sometimes a personal planned decision, sometimes it’s a surprise.

I know people who never want to pay a dime in tax until they absolutely have to even if it means a penalty and others who never ever want to get even a dollar penalty so partly that’s what I mean by it can be a personal decision.

I’m not trying to diminish whether you get a refund or not, but rather suggest that the focus be on the total tax that you owe for either a year or your lifetime and not the net effect of the annual tax return.

Let’s start off with the concept that tax laws are written in pencil. They're constantly changing.

However, there are core foundational pieces of information on how your annual and lifetime tax bill is arrived at and when you start to understand those you start taking control of your taxes instead of being reactive and letting taxes happen to you.

Details of tax laws change almost every year but the foundational concepts do not change and that's why it's very important to understand that whether you're a W-2 wage earner or you're self-employed (or both) you can control to a certain degree how much tax you pay this year and across your lifetime.

Especially if you are a small business owner or self-employed you have more options and methods available to you but folks who earn a paycheck have some control too.

There are far too many methods and items to cover in one article so decide to start to learn because this is an education that can have a real financial return in the form of paying less taxes. 

Those who have been getting these weekly newsletters have seen lots of tax saving ideas, some have been posted back on my blog site so you can read them there, Blog tab.  There is a seven-part series called Anatomy of a Tax return based on the 2021 tax return format.  I expect to update that eventually for 2022 return line items but the concepts remain the same.

As an example of total tax, look at line 24 of the Form 1040 page 2 for the 2022 tax return just finished.

Let’s say that based on your family income that the Total tax line was $20,000.  Some are less than that, but many are higher than that.

Now, think of how many more years you will be working until retirement, 10, 15, more?  And you expect or hope to make at least that much income or more in the remaining years before you retire.

What if your total tax was $20,000 for 2022 and you expect to work at least another 10 years?  That’s at least another $200,000 in tax you will owe before you retire. 

What if you could trim say 5% of that tax simply by becoming more educated on tax planning and financial planning instead of just hoping that each year you get a refund on your tax return which was really your money anyway.

Now, let’s carry this further, what if your tax bill dropped in retirement and now your total tax is only $10,000 on that line 24.  Yay?  Maybe, but many people are living longer in retirement due to better medical care and lifestyles.

Let’s take that working life tax example and apply to retired life. Your new tax bill in retirement is only $10,000 each year, but you’ll live 25 years in retirement.

That’s still $250,000 of tax you will pay during your retired years, when you are no longer getting a paycheck.

Would that make sense to do some long-term planning now, and possibly even choose to pay more tax now while you are working to avoid a large retirement life tax bill when it’s not so easy to go out and get more income?

This is why I emphasize that financial planning without tax planning is only solving half the problem and why in my opinion if you are getting financial planning help without long-term tax help you are very likely paying more in tax than you have to which means less money in your pocket to use for your goals.

If your financial planner has not asked to see your tax return ask them why not and how can they give financial advice when every financial decision has a tax consequence?

Also don’t confuse having your tax return done as being the same thing as tax planning.   A tax return can be 100% accurate and still not be a good long term tax plan, because a tax return is a reconciliation what happened last year, not a future plan to lower your lifetime tax bill.

I’ve heard it described as a tax return is like looking at the rear-view mirror in your car, it’s looking at what’s behind you because the year is over and you have to report that to the government and true up your tax situation.

But tax and financial planning is like looking out the front windshield of your car, it’s looking at where you might be going or would like to go and steering your financial planning in that direction and making adjustments along the way.

If you’re ready to start being proactive about tax and financial planning let’s set up a call.

Do you remember a past article but don’t remember the date it came out?  Many articles are also posted on my Blog site so visit there.   More are being added over time.  While you are there visit the resources tab and sign up for the downloadable resources available to you.

The information in this and other articles is intended to be educational in nature only.  Not tax, legal or investment guidance for you specifically.  Each person’s situation is unique and you must seek appropriate professional guidance that can address your unique situation.

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