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What Is a Tax Refund Anyway? Demystifying and Maximizing

February 22, 2018
Personal finances: What is a tax refund?
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For many, tax season may all boil down to one thing: How big will my tax refund be?

As of the last day in 2017, the Internal Revenue Service had processed 151.9 million individual income tax returns for the 2016 year and issued 111.9 million refunds totaling $323.9 billion. The average refund was $2,895, up just a shade from the 2015 average of $2,860.

Given the amount of hoopla surrounding the new tax bill, it’s probably worth noting that the new rules affect money earned in 2018, which you won’t report until you file your 2018 tax return in 2019. This year, what you’ll file by April 17—tax filing procrastinators, rejoice; you get two extra days—will be for what you earned in 2017.

What Is a Tax Refund? How Does a Tax Refund Work?

If you’re like many taxpayers—most, according to the IRS figures above—you might pay too much in taxes over the course of the year. In a sense, you’re giving Uncle Sam an interest-free loan. A tax refund is the government paying you back what you overpaid.

Paying too much and then getting some back come tax time can actually help people who aren’t great at saving, said Lisa Greene-Lewis, a certified public accountant and tax expert for TurboTax. If they didn’t have that additional money taken out of their paycheck, they might just go on a shopping spree.

“A lot of people rely on that refund to pay down debt or for an emergency fund,” she said.

What Is a Refundable Tax Credit?

Similar to tax refunds is something called a refundable tax credit, such as the earned income tax credit or the American opportunity tax credit. Unlike nonrefundable tax credits, refundable tax credits allow you to get a refund even if your tax liability is zero. For more on tax credits, please refer to this recent primer.

If the government owes you a refund, you can request direct deposit or a mailed check. Direct deposit is typically faster. The government issued $270.8 billion in direct deposit refunds last year through December 29.

Using Retirement Savings to Boost Your Tax Refund

Want to know how to maximize your refund? The no. 1 thing people can do to get a bigger tax refund this tax season is to continue to contribute to an individual retirement account, Greene-Lewis said. You have until the tax return filing deadline—just a reminder, this year it’s April 17—to contribute up to $5,500.

If you’re a low- to moderate-income taxpayer, contributing to your IRA may make you eligible for a credit of up to $1,000 if you’re single or $2,000 if you’re married and filing jointly, she added.

A Look Toward Next Year’s Tax Refund

As for your 2018 earnings, lower tax rates mean more money in your paycheck, with people seeing more dough starting in February, Greene-Lewis said. Why? The 2018 tax law lowered the thresholds in most tax brackets. Plus, a doubling of the standard deduction, as well as the child tax credit, might lower what you will owe in taxes. 

That means you should consider adjusting your W-4 form to make sure you have the right withholdings.

It’s true that some taxpayers view overpaying during the year as a sort of “forced savings,” and that those extra withholdings prevent them from blowing too much money on a new pair of shoes or an expensive meal. But there are alternatives to giving the IRS an interest-free loan. Perhaps you could set up an automatic deposit into an interest-bearing account such as a savings or money market account. You’ll not only earn a bit of interest, but you’ll also have an extra escape hatch should you need it.

Getting a tax refund might feel like free money, but it’s not. It’s your money.

TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.

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