Definition and Examples of Tax Refund
A tax refund is a compensation issued by the government when a taxpayer pays more taxes than they owe. Typically, the taxpayer receives the excess amount via direct deposit or paper check.
How Does a Tax Refund Work?
When an employer pays an employee’s salary, they withhold a portion of the employee’s total salary for tax purposes. The amount withheld is based on the withholding tables set by the Internal Revenue Service (IRS) and the information the employee provides when completing their W-4 form (such as marital status and tax exemptions).
After submitting the tax return, three potential scenarios can occur: the withheld amount is correct, and the taxpayer does not owe or need to refund any amount. The withheld amount is less than the taxpayer’s tax liability, and the taxpayer must pay the remaining balance to the government. The withheld amount exceeds the taxpayer’s tax liability, and the government owes the taxpayer the excess amount, issued through a tax refund.
If the taxpayer is entitled to a tax refund, there are different forms the refund can take. Many taxpayers choose direct deposit as it is the fastest way to access the refund, but taxpayers can also choose to receive a paper check by mail. There are other types of tax refunds as well (we will get to this topic later).
Note: You can check the status of your refund within 24 hours after filing your electronic tax return (or after four weeks if you mailed your return). The IRS typically issues tax refunds within 21 days of processing the tax return, without any delays.
If you receive a tax refund by check and the amount is less than you expected, the IRS will provide a notice explaining the reason and next steps, if necessary. If it is confirmed that you should receive more, you can cash the check you have already received, and you will receive another check for the remaining amount.
Types of Tax Refunds
In addition to direct deposit to a checking account or paper check, taxpayers can also receive tax refunds in the following ways:
– TreasuryDirect: Deposit the tax refund into a TreasuryDirect account to purchase U.S. Treasury bonds.
– Direct deposit to retirement accounts: Deposit all or part of the refund into a traditional IRA, Roth IRA, or SEP IRA.
– Savings bonds: Use the tax refund to purchase Series I U.S. savings bonds, with a maximum of $5,000.
– Savings accounts: Deposit the tax refund into an eligible savings account, such as a Health Savings Account (HSA), Medical Savings Account (MSA), or Education Savings Account (ESA).
Note: Taxpayers who choose to receive their tax refund via direct deposit can file Form 8888 “Allocation of Refund” to instruct the IRS to send the refund to a checking account, savings account, or retirement account. In most cases, you can split the refund and send money to three different accounts.
Advantages and Disadvantages of Tax Refunds
Receiving a small amount of cash via a tax refund is something many taxpayers look forward to. With proper financial planning, a tax refund can help them reclaim their savings or prepare for a major purchase, such as a down payment on a home. For some, having extra cash in reserve is useful for covering unexpected expenses, like an emergency medical procedure.
Some critics, however, consider a tax refund essentially a repayment after giving an interest-free loan to the government. Instead of overpaying taxes, taxpayers should adjust their tax withholdings to match the taxes they actually owe. The amount you would have received from a tax refund can then be invested or stored in a retirement account like a 401(k).
How to
Getting Your Federal Tax Refund
Some taxpayers choose to file their tax returns themselves and can download the appropriate tax filing forms from the Internal Revenue Service. Taxpayers often use tax preparation software to simplify the tax filing process. Others pay an accountant to file their taxes, preferring the convenience and expertise that a professional provides.
The Volunteer Income Tax Assistance (VITA) program offers tax services, including virtual tax preparation and return submission services. This program is available for taxpayers who earn $58,000 or less, who are over the age of 60, who have disabilities, or who speak limited English.
Key Takeaways:
– A tax refund is a compensation issued by the government when a taxpayer pays more taxes than they owe.
– A portion of an employee’s salary is withheld for tax purposes when paid by the employer.
– After filing a tax return, three potential scenarios can occur.
– Taxpayers can receive their tax refund in various forms.
– A tax refund can have both advantages and disadvantages.
– Taxpayers can receive their federal tax refund in different ways.
Sources:
– Internal Revenue Service. “Publication 15-T: Federal Income Tax Withholding Methods,” pages 11-25. Accessed January 26, 2022.
– Internal Revenue Service. “Topic No. 152 Refund Information.” Accessed January 26, 2022.
– Internal Revenue Service. “Form 8888: Allocation of Refund (Including Savings Bond Purchases).” Accessed January 26, 2022.
– Internal Revenue Service. “Free Tax Return Preparation for Qualifying Taxpayers.” Accessed January 26, 2022.
Source: https://www.thebalancemoney.com/what-is-a-tax-refund-5216789
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