A Tax Refund Is Not Ideal
“The producer supplies all the money; the director spends it. Then the producer yells that the director is spending too much money.” - THE MIRROR CRACK'D
written by Jonathan Hales & Barry Sandler, directed by Guy Hamilton
(3.5-minute read)
I often see people get excited about receiving a tax refund when filing their taxes. I can’t blame them. If I was told that someone was giving me a three-thousand-dollar check, I’d be kicking my heels! Some will proudly state that they use their tax refund in order to go on a trip, or buy that new toy every year.
This is not something to brag about. If you’re counting on a big government payday every April 15th, then chances are you’re doing something wrong. You didn’t plan correctly. Even if your income is unpredictable, as it is for screenwriters, directors, and the like, you can still do a better job of predicting how much to give the IRS each year.
GET A BILL, NOT A PAYCHECK
If you’re like most people, the biggest payments you have every year are your tax payments. Preferably you want to owe just a little something to the IRS each year when you file. Not owing anything, but also not receiving anything, is the best-case scenario.
I’m not going to get into the minutiae of tax payments, penalties, and interest. That’s a different blog. But the U.S. government wants their money. They also don’t want to wait until April 15th every year to get it. They got bills too! So, at the worst, they’d like you to pay them every quarter. Many of us have these payments withheld from our paychecks, and that makes the government happy (enough).
If you get money back every year, that means you gave the government too much money throughout the year. They’re just returning the money that was rightfully yours. But they’re also returning it interest-free. It’s like you gave the government an interest-free loan for a year. This is money you could have used throughout the year. Even better, this is money you could have invested throughout the year and have it be worth more come April 15th of next year. But instead, you gave it to the government, they held it, then gave it back to you later. Inflation ate away at the value of your money, so now it’s worth less than what it was when you loaned it to them.
Therefore, you’d ideally like to keep as much money as possible. On April 15th, if you owe the IRS twenty dollars, for example, then you gave them just enough throughout the year. You kept as much of your money that was yours to begin with and used it properly.
FIGURE IT OUT
If you predictably receive a big tax refund, and you have W2 income (A.K.A. receive a paycheck from an employer with taxes withheld), then you can simply have them withhold fewer taxes from your paycheck. You can fill out a new Form W4 and give it to your employer. That form is HERE.
What if you have unpredictable income or get paid through your Loan-out company? There are online calculators that can help you predict how much you might owe. HERE’S ONE. If you have been setting aside money for taxes, which is something I recommend for those with unpredictable income, then you’ll be able to assess if you’re on the right track. These calculator numbers aren’t 100% accurate, but they should give you a ballpark estimate.
You can also figure out what your Effective Tax Rate might be and plan accordingly. That online calculator shows you that number as well. Your Effective Tax Rate is the actual tax rate of all your income combined. If you know the ballpark figure of your Effective Tax Rate, then you should know approximately how much should be given to the government.
Perhaps you’ve been setting aside 25% of your Loan-out’s paychecks for tax purposes. But, once you run the calculations, it turns out your Effective Tax Rate is 18%, then you may be able to pocket that additional 7% and put it to work. Don’t forget: if you have a Loan-out, then you will probably have business deductions which will lower your taxable income.
As always, seek a tax professional to help you with these calculations. Make sure to do your own research. I have not vetted the accuracy of these sites. Your situation is unique and involves more detailed planning. This blog should not be considered tax advice.
If you’d like more information about Financial Planning, you can schedule a complimentary meeting HERE.
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