Budgeting and the Tax Debate

Monday was officially the deadline to file taxes for 2018 so of course there were several conversations in the office regarding this topic. The main debate was on the topic of maximizing a refund vs. trying to break even by balancing withholdings from paychecks. At first blush this may not appear to be a budgeting topic, but trust me it is.

The goal of taxes from an IRS standpoint is to have the taxpayer be as close to paying the correct amount of taxes by the end of the year as possible. When I took taxes as part of my accounting degree the professor drilled this concept into our heads. He always said, “If you get a refund at the end of the year that means you just gave the government an interest free loan.”

Okay this is a fair point, especially from an academic standpoint. However, a classmate countered with “I know it is an interest free loan but I do not have the discipline to set aside money. I let them hold on to it and at the end of the year I get a little bonus to splurge on something, maybe a vacation.”  

From a budget perspective tax withholding can have a significant impact. On the one hand, if you keep as close to the actual amount owed as possible you can maximize the amount of money you control. This can help pay bills. Under these circumstances you have to budget the extra money and save it if you want to splurge, like my schoolmate.  I can hear her now “Boring.” In my case I am usually within +- 100 of balanced. It is difficult to be exactly on target. The closest I ever got was owing $15.

On the other hand, if you like the feeling of a yearly bonus tax refund time is a favorite time of year. Saving a little each paycheck to finally add up to the amount it would take to go on a vacation does not give the same rush as getting a big sum all at once on a refund check. You still saved, you just tricked yourself into doing it.

The other benefit of having more taxes withheld from paychecks is you have a cushion when you unsure how much you will owe at the end of the year. It might be better to over withhold than to face a huge tax bill at the end of the year. Especially, if you don’t have the money when the bill comes due.  

I used to volunteer to do taxes for soldiers when I lived overseas. Some of the common reasons people would end up owing money without realizing why are:

  • You and your spouse have jobs, the pay is in a specific tax bracket. Add the income together at the end of the year and now you are in a new tax bracket.
  • Soldiers retire, get new jobs, earn retirement pay, and when all the income is added together at the end of the year, new tax bracket.
  • Forgetting to change deductions when kids leave home and they start claiming themselves on their own taxes.
  • Forgetting to change deductions when marital status changes.
  • Not realizing that you have to pay quarterly taxes on side jobs. This got the personal trainer I worked with.  Taxes for self-employed people are a bit complicated.  People don’t realize that their employer kicks in a certain amount. When you are self employed you pay both parts.

What school of thought are you from; Do you prefer to balance the taxes and keep your money throughout the year?  Or do you prefer to get the refund at the end of the year? The debate among my colleagues goes on 😊

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