The Tax Return Spectrum

by Kevin on February 19, 2009

I finished up our taxes on Monday with Tax Act Online. I’ve used them for the past few years without problems. We use the Deluxe Federal and State package which only cost us $12.95 this year. There is a lengthy questionnaire and you can look up specific topics if the questionnaire misses it. Once you finish you e-file and can expect your return within a few weeks assuming the federal or state government accepts your return.

Last year we owed a few hundred dollars to the federal government, and the state owed us just a little bit less than what we owed. The end result being we paid a little bit out of pocket to the IRS.

This year the situation is similar, but we’re on the positive side of the fence. We owe the federal government a decent chunk of change, but the state of Alabama owes us even more! The end result? We’ll have close to $300 to put toward paying off our second mortgage.

So, would you rather owe taxes to various government agencies, or would you rather be owed taxes?

The answer, as it is with most things, is it depends. Don’t you love that?

I’d like to introduce a concept called the Tax Return Spectrum.


(Forgive me for the quality as I just threw this image together in Gimp this morning!)

The middle of the spectrum — the black line — is owing $0 additional in taxes and getting $0 back as a refund. This is the best result possible because it means you haven’t loaned the government your money for free, but you also don’t have to come out of pocket to make up the difference. All the money you put in your bank account and spent throughout the year is yours to keep.

It’s also nearly impossible to get to exactly even with taxes due to our complex tax code. Sure your W-4 has a worksheet that attempts to take into account your life situation (married vs. single, dependents or not, etc.), but tracking your itemized deductions and what type of difference that will have on your tax return is really difficult. For example our mortgage interest had a huge impact on our tax situation this year, and it would be a pain to calculate what we thought we might pay in interest… on top of our charitable contributions and things like that.

The green areas close to the black line is what I would consider the good area. Yes, even if you owe a little bit of money that’s still better than owing a lot of money (or being owed a lot of money). So if you owe $200 and you aren’t constantly strapped for cash, you should be able to absorb that blow to the budget fairly easily.

The further out you move from the black line the worse the situation becomes. This may sound silly to have getting a lot of money back being just as bad as owing a lot of money, but in my eyes it really is. I’ve heard of people getting $5,000 or $10,000 back from their tax returns. That’s a ton of money that you didn’t have throughout the year to apply to your budget. You need to make some drastic changes to your withholdings to get that number down.

If You Enjoy Big Tax Refunds

If you typically get a large amount of money back each year from the government, I’ve got some comments.

Some people prefer large tax refunds because it forces them to save money. I know one person who uses the money to pay off credit card debt and set aside savings. I really hate this idea. It reeks of a lack of discipline in your financial life. If you always use your tax refund to pay off debt and save a little bit of money, you have a problem. Why? Because each year you are having to pay off credit card debt. You’re counting on that big refund to save your bacon from the fire. You haven’t made any changes to your financial situation. You are treading water every year.

How can you use that money during the year? Adjust your withholdings and calculate how much “extra” money you should be getting each month. Give that money a name and put it to use in your budget — perhaps just set it aside in savings.

If You Owed a Lot of Taxes This Year

Let’s say you just had to foot a big tax bill or set up a payment plan. That’s not good. Maybe you had your withholdings set up so you would owe a lot of money because you needed the money during the year. The question remains: where will you find this extra money to pay the government?

Getting back to the green area should be a goal for you, too. Owing too much money can result in penalties and interest from the government.

So what would do you prefer: to owe taxes or to be owed taxes back? Me personally I prefer to get just a tiny bit back. I’d much rather be exactly even, but I realize that isn’t really possible. What about you?

{ 2 trackbacks }

The Correlation Between Aggressive Driving and Aggressive Spending | Personal Finance Firewall
February 27, 2009 at 8:43 am
Check Your Income Tax Refund on Your Smartphone | Truth Stars
March 4, 2011 at 9:54 pm


Richard February 19, 2009 at 10:17 am

I have lived overseas since 1984, so I never pay or get a refund. I still file, but someone living outside the US is not taxed on the first $100,000 or so and I’m not quite there. When I was in the US I always tried to have no refund, or get as close to $0 as possible – a little either way didn’t matter. I did have one friend that liked to get a big check, he probably still does. That was the only way he could save for vacation. This may sound funny, but loaning the government money was a way to be sure he had vacation money. I have learned that it is best to never argue with vacation-logic.

Smart post.

Budgets are Sexy. February 19, 2009 at 1:24 pm

Hah! I actually did my post today on this same thing 😉 File me in the group who LOVES getting a big chunk every year. And $6k this time – out biggest ever.

yeah i know it sucks giving out a “free loan” and all, but knowing this chunk comes ever year (and w/out budgeting for it) it REALLY makes a difference in your mood – esp w/ the weather these days…

Personal Finance Firewall February 19, 2009 at 9:07 pm

As long as I do not owe anything I have no complaints. I never count on the tax return and never even think about it until the time comes to actually file. I would really be as close to zero as possible because it is essentially a loan to the government interest free, and I would rather loan that to a bank at an interest rate just higher than zero. But to each his/her own.

Scott @ The Passive Dad February 20, 2009 at 12:47 am

Living in California I’ll say that I’m an idiot for receiving a refund this year. I would much rather owe the state as we don’t know when we’ll get our money back. IOU’s are only good when playing Monopoly as a kid, not in real life.

Crunchygeek February 20, 2009 at 6:57 am

I am so glad to see that someone else uses Tax Act. I have used it for at least 3 years now.

I’m very satisfied with it.

I have 6 kids, so I get a large refund due to the child tax credit. It is a nice bonus this time of year, but I wish I could get it throughout the year.

The Personal Finance Playbook February 20, 2009 at 8:42 am

I use TaxAct, too. I’m a little behind on filing this year, though. My goal is to get them filed this weekend.

Gump July 11, 2011 at 1:14 pm

This makes evertynihg so completely painless.

LAL February 20, 2009 at 12:42 pm

I like owing, typically under $1k though.

[email protected] Wasn't In The Plan February 20, 2009 at 9:38 pm

After filing our taxes last year (and receiving a big refund), my husband filled out a new W-4 so less taxes were takes from each paycheck. This year’s refund was considerably less, but still a refund, so he’ll be filling out a new W-4. So yeah, we’re not fans of the huge refund!

Kevin February 21, 2009 at 11:36 pm

@Budgets are Sexy: Wow I can’t imagine having $6k land in my lap. There is a piece of me that wonders if our tax software is catching everything that a CPA would. Hmmm…

@Scott: That is truly an odd situation out there in California. Hoping you aren’t expecting a lot back!

@crunchygeek: right back at you! I thought I was alone 🙂 Software seems good enough for me when you go through all of the forms and whatnot. Could you figure the child tax credit into your taxes/W-4 forms up front and get more during the year?

@Personal Finance Playbook: Well there’s 3 of us then!

@Alison: Again I would rather have a tiny refund than a big IOU from the government, but the closer to 0 the better.

Russell Fascenda February 23, 2009 at 5:03 pm

I agree the idea of the “refund” is silly, I try to explain it’s not a refund of anything, it’s “change” from your payment. How about if every time you went to McDonald’s, they never gave you any change from your purchase. They just said we’ll hold onto whatever you overpaid, and at the end of the year we’ll give it all to you at once.

If you need help saving, why not have your employer split your direct deposit into two accounts, one a savings account and another a checking account. Even if savings doesn’t earn much these days, it’s under your control.

Now if you’re really shrewd, reduce your withholding, save some of the excess take-home pay, and make a rough guess at your tax bill the first week of January. Send an estimated tax payment on January 15 to make up what you under-withheld so you’ll have no penalty on the return.

Kevin February 25, 2009 at 8:36 am

@Russell: Great analogy. And good plan — split the extra money off into a savings account.

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