At this time of year, personal finance professionals switch from chiding us about filing our taxes on time to chiding us about getting refunds. To get a tax refund is proof that we overwithhold, they say. It's proof that we can't manage our finances properly. Worse, receiving a tax refund is proof that we taxpayers are childish, incapable of saving unless Big Brother holds our money for us and only gives it back once a year, without paying any interest.
I don't think so. Federal law has allowed the IRS to behave over the years in a terrifying manner. It has seized people's property, shut down their businesses, hauled them into court, and even sent them to prison over unpaid taxes. What people fear most about the IRS is owing money. They may specifically fear an audit, but more generally, the fear is that they'll come up short on April 15, and not have any ready cash to pay what they owe. Then they'll owe interest and penalties, both of which mount up very quickly. Once a taxpayer gets into tax debt, it often takes years to clear the account.
A letter from the IRS is scarier than a cease-and-desist letter from a lawyer threatening a lawsuit. Those at least are clear about what the perceived offense is and how to stop further action. The IRS often sends letters people don't even understand, demanding money according to tax schedules the taxpayers never used, about taxes filed years in the past. The IRS also has a well-deserved reputation for bullying taxpayers over very small dollar amounts, in order to terrify the rest of us. It works.
How do taxpayers protect themselves from the threat the IRS represents? We overwithhold. It's a simple yet winning strategy. Maybe when banks were paying 5% interest on savings accounts, we might have been tempted to underwithhold, and just pay up on tax day. But that strategy doesn't help us sleep at night, and banks these days don't pay interest worth talking about.
Laughably, several of the articles I've read that sanctimoniously say we're fools to get refunds also say that we should have put that refund money, month by month, into the stock market and made a killing. Right. We also could have lost it all. This is not brilliant advice, and it's not even a sane comparison. Comparing a speculative, uninsured stock investment to the dependability of receiving a tax refund from our stable federal government is nuts.
There's also the little matter that Congress changes tax rules every year, but drags its heels and often does it on the last day of December. How are taxpayers to plan in January for not-yet-enacted new tax rules? We can't.
Overwithholding gives the government free use of our money, the critics say. But we the people are the government, so we're saving ourselves the interest the government would have to pay to borrow the money we're lending it for free. Our patriotic gesture, in fact. Meanwhile, we're also arranging for forced savings that can result in a large chunk of cash that we'd never see in one place otherwise. Could we obtain that chunk of cash by mere savings? Not easily, because there are so many daily demands on our money.
By overwithholding, we create a happy tax time scenario: We're getting a refund! Hurray!
The financial critics should lay off.