Is it better to get a smaller tax refund?

Many tax filers end up getting a refund each year. A smaller refund might seem like a bummer, but it actually means you did a great job of estimating your tax obligations.

fool.com - Getting a Smaller Tax Refund Than Usual? Here's Why That's a Good ...

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Less money isn't necessarily bad.

Key points

Many tax filers end up getting a refund each year.

A smaller refund might seem like a bummer, but it actually means you did a great job of estimating your tax obligations. The majority of people who file a tax return each year end up getting a refund. And if you're one of them, that refund may be something you're used to celebrating. After all, you suddenly have a lump sum of money hitting your bank account.

But what if this year's tax refund is a lot smaller than it usually is? What if you typically get $2,000 back from the IRS, only this year, you're getting just $600?

A smaller tax refund might seem like a bad thing at first glance. But here's why it really isn't.

It's all about getting your money sooner

A tax refund is not a gift from the IRS. Rather, when you get a refund, what the IRS is doing is returning money it took from you the previous year that it shouldn't have collected. And so if you're looking at a smaller tax refund this year, it means the IRS withheld less of your earnings last year, which is not a bad thing at all. Remember, the system we have in place for taxing wages is imperfect. Your employer will try to estimate your tax obligation based on information you put on your tax forms, but there are different variables that come into play to determine what IRS liability you have. These include:

How much income you earn from a side job

How much interest you earn on money in savings

The amount of gains you earn in a brokerage account

The number of deductions you're eligible to claim on your taxes, and their value

The number of dependents you have

The tax credits you're eligible for, and what their value is (sometimes, the value of a tax credit can change from year to year, such as the Child Tax Credit, which got boosted in 2021) Clearly, that's not a small list of factors. And it explains why tax refunds are so common. But remember, any time you get a tax refund, it means you paid the IRS too much the previous year and gave the government an interest-free loan in the process. If you're now looking at a smaller refund, it means you kept more of your money as you earned it and didn't have to wait as long to get it.

Don't fall back on your tax refunds

Some people routinely fall back on their tax refunds to pay bills or meet other obligations. But a better bet is actually to assume you aren't getting a refund and keep your expenses to a level your paycheck can cover. If you generally get a large refund but struggle with bills during the year, it could pay to adjust your tax withholding so your paychecks increase. There's really little to be gained by having the IRS hang onto money you're entitled to. And so rather than have to wait to collect what you're due in refund form, you're better off seeing your paychecks go up so that money is available to you month after month as your bills roll in.

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