A couple of weeks ago, I asked my readers to share their favorite tax preparation software. I’m doing my own taxes for the first time this year, so I was hoping to make a decision based on the feedback. However, there wasn’t a strong consensus among my readers on the best tax preparation software, so I decided to just go with the most popular software — TurboTax.
Last night I started filling out my taxes using TurboTax Online. It was surprisingly simple and convenient. You don’t have to pay for the software until you actually file your taxes, so you can find out how much you will owe or get back from the government for free.
About an hour after creating my TurboTax account, I had finished going through the interview style questions, and I had a pretty good estimate of what my tax return is going to look like this year. It looks like I owe the IRS some tax money. I made a lot more money from my second job and this blog than I expected, and now I get to pay the taxes to prove it.
It may seem like bad news, but is it really? Sure, getting a bill instead of a check isn’t very psychologically rewarding, but it makes more sense from a financial perspective. Instead of letting the government hold on to my money, I kept all of it (and some of their money) in my own hands and earned interest on it.
On the other hand, people that receive a big tax refund have given an interest-free loan to the federal government. This is bad from a financial point of view, but it’s way better for your mind to receive a check from Uncle Sam rather than to write him one.
This leads me to ask the following questions. Does the psychological advantage of receiving a tax refund outweigh the financial benefits of using the government’s money for extra interest? Do you think it’s better to receive a tax refund or owe the IRS?
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{ 11 comments… read them below or add one }
Personally, I’ve always thought that it’s much better to hold on to the money and pay the IRS when I send it my tax stuff than to get a refund back. Like you said – it’s an interest-free loan to the government. During the year, if I’m not loaning that money to the government, I can throw it in a high interest savings account (if any really existed anymore) or use it in some other way to make money.
Throw me into the “giving the gov’t a loan” boat all the way – I totally love it. I’m a sucker for feeling like I just got handed a pile of “free money” every year
It may not be the smartest thing financially, but it sure is personally (to me).
Now just gotta figure out exactly what to do w/ our biggest sum – $6k! aww yeahhh bow chicka wha wha.
I think it is better psychologically to receive a check. For some people, getting a bundle of cash once a year helps to not spend that extra money. For me, it was a life saver, I was able to pay bills that were coming in from a medical condition. Although I could have been smart and saved for this during the last couple of months, I let it go and now I have a way to pay it at once. Otherwise it would have gone into savings.
I agree with J. Money. For me, the psychological benefit of getting a big chunk of money all at once vastly outweights the extra pennies I might have earned in interest.
Besides, couldn’t our government really use an interest-free loan right about now?
Do you pay quarterly estimates? You may get whacked with a penalty for your side job and blog if you don’t.
I’m with you, Broke Grad Student. Better not to give the government an interest free loan. People who get so excited about a refund should realize they could just have the bank take that much out automatically and put into a savings acct. Then they’d get interest AND still not spend it (which is the common excuse for letting the IRS keep the funds).
The only caveat is this: Always be sure that you at least pay as much in taxes as you owed last year. So long as you do that, the IRS won’t charge you penalties for missed taxes. My thought is that they assume so long as you paid however much you owed tax-wise last year, then you were trying in good faith to keep up with your tax burden.
If you don’t want the hassle of quarterlies, just have your primary job withhold more taxes — HR can probably help you figure out how much you’d need to withhold.
I owe and I pretty sure it sucks. But at least they weren’t sitting on my cash for a year.
Mike: No, I didn’t pay quarterly estimates last year, but I have paid enough tax to avoid the underpayment penalty. I’ll probably pay quarterly estimates this year to ensure that I don’t get hit with the penalty.
I’m on the side of getting a refund back. Sure, you technically are giving the gov’t an interest free loan, but how much interest do you expect to earn on that sum? I also feel that many people don’t have the cash on hand to make up any taxes they still owe when they’re hit with a bill all at once. The need to scrounge up some cash quickly leads to putting other expenses on a credit card and then getting slammed by those interest rates. I’d rather get a lump sum back, which I could then use to put towards paying off student loans faster or to invest at that time. I should note that I feel its important to have a plan with what to do with your refund money, even before you know the amount. For example, say I’m going to take 80% and use it to put some extra money toward student loans. I’ll invest the other 20% in my IRA. Otherwise, I think it’s too easy to spend that money and then look back and wonder, “hey, where’d it all go?” Note: I don’t necessarily believe that you have to put that money towards retirement or paying off student loans; that’s just my current situation.
I have trouble saving every month, but now with my refund (deposited yesterday), I now have my emergency fund of $5,000 and some extra I can throw towards my credit card debt.
Let’s spend just a second looking at the following comments:
- “I think it’s too easy to spend that money”
- “I now have my emergency fund of $5,000 and some extra I can throw towards my credit card debt”
- “extra pennies I might have earned in interest”
All of these comments support a central theme that we as Americans have no idea how to properly maintain our finances. The first step in financial management is to create a budget and stick to it – this eliminates the “too easy to spend it” conundrum.
Additionally, with your budget, you have the ability to set aside money for an “emergency fund” before-hand. This should effectively eliminate the need for credit cards, and thus eliminate credit card debt. Just everyone think to yourselves for a moment that commenter #2 has been paying between 5% and 15% interest APR on his / her credit card – rather than paying it off monthly. This should be considered as a loss of 5% to 15% rather than a benefit.
Finally, if you’re receiving a refund of $2,500 (just for example) you would not earn pennies on this money, rather, you would earn an extra $100 over the course of the year at 5% interest. (Bear in mind that you don’t have the initial 2,500 all at once and can’t simply multiply 2500 X 0.05. You need to calculate it with installments and compounding interest.) Better yet, if you have a home loan or a second mortgage like most Americans – pay this extra money against the principle and consider your mortgage rate (i.e. 6%) as interest paid to you. This will be far higher than any “high interest” savings account.
Smart decisions and sound financial planning lead to long term success.