Before going out and spending your tax refund check, take some time to understand where that refund comes from.
Upon getting hired, your employer had a W-4 filled out in which you selected how you wanted your income taxes to be deducted from your paycheck by confirming your marital status, dependents and other information. As a result, the payroll office can estimate your tax rate. In the following paychecks, a percentage of your gross pay was taken out and sent to the IRS as your withholdings. The formula for withholdings is designed to protect people from having to pay money after taxes are filed. If the right amount of money is withheld, the IRS should get the money that is due. Withholdings are designed to lean closer to over-withholding so that those who experience financial hardships would not have to pay taxes in April.
When completing your tax return and determining your deductions and credits, you may find that your income is lower than what your employer estimated and you’ll receive a refund. This means the government pays back some of the money that was being withheld.
On your paycheck, tax credits such as Earned Income Tax Credit and Dependent Care Credit are not reflected if you are eligible for and receiving them. If your income changes throughout the year, estimating your tax credits on your W-4 may be complicated and you may find that your tax credit isn’t worth that much. A raise or promotion that you received can also cause a hassle due to more money being withheld.
To help determine if you need to adjust your withholdings to ensure you’re not overpaying your taxes, you can use the IRS calculator and then file a new W-4 at any time, if need be. It is better to overestimate, rather than underestimate, as you can do a lot with the money you would receive. The money you receive could go to pay down high interest debt, including student loans and credit card bills. You can also start an emergency fund to prevent yourself from debt due to unexpected expenses. Adding to your retirement fund or starting a budget for a side project is also a good use for that money. Once you develop a plan, be sure to stick to it and see it through.
Review your taxes and see where you can be saving money. Be aware of where your money is going and develop a plan to keep yourself from falling into debt.