Updated on 03.11.11

The Tricky Tax Refund

Trent Hamm

Like many self-employed folks, for me April 15 means a day to write a check to the government. Even if I do manage to get a refund, I’m still writing a check on that day to pay my first batch of estimated taxes for 2011. It wasn’t all that long ago, though, when April 15 usually meant that I would be receiving a tax refund check.

Back in those days, my tax refund check was a wonder. It usually meant some sort of giant splurge. I remember using it to purchase a new television and a PlayStation 2 in one day using my refund check in 2002 or so. In 2003, I used that refund check to buy two plane tickets from Chicago-O’Hare to London-Heathrow for a honeymoon for Sarah and myself.

Later on, especially in 2005 and 2006, our refund check usually went straight towards debt repayments. I’d deposit the check, then immediately go home and write some checks to various creditors to cover things I’d already purchased.

At this point, our tax refund wasn’t a help – it merely helped sustain an unsustainable lifestyle for another month or two. It made our awful decisions seem a little less awful and made it seem reasonable to continue making them (although, by the time the 2006 refund rolled around, we had enough sense to keep our spending under control and used the money for positive financial change).

In 2007, though, we used our tax refund to contribute to the down payment on our home. This was, of course, a positive use for our tax refund as it went toward a tangible asset. (Since then, of course, tax day has meant paying in more than we receive.)

Simply put, your tax refund check presents you with a choice.

Are you going to use it to put yourself in a better financial position? Are you going to pay off a debt – and not immediately run up a credit card? Are you going to put it towards a house down payment? Are you going to use it to save for a replacement car? Maybe you’ll use it for more education, or perhaps you can invest it in a small business. Maybe you can even drop the money into a local charity, which improves your community. All of these choices will pay you dividends for years to come.

On the flip side, you could buy a new television or take a trip with that money. Of course, as soon as that television is bought or that trip is over, you’re back in the same position you were in before.

Which side of that coin do you want to be on?

A final thought: not having a refund check has been a very positive thing in my own life. It’s forced me to be more careful about my day to day finances knowing that at the end of each quarter, I would be paying the IRS, and that at the end of the year, I wouldn’t be getting a check. Yes, the money was all equal in the end, but instead of having the government “save” my refund for me, I was doing it myself. I had to make the right choices, and I was able to reap the rewards of those choices.

Having that “bailout” check at the end of the year was a crutch that kept me from financially walking on my own two feet. Putting it aside made me stronger.

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  1. I’ve backed off the “refunds are bad” camp in recent years. The benefits to getting a refund are numerous and with interest rates this low, you’re not really “loaning” the government much at all if you’d been investing the money in a risk-free fund.

    This year, I’m using a portion to catch up on last year’s IRA, using some for 529 and the rest for vacation. Who knows, would I have had the discipline to set aside the same amount during the year had it been in my paycheck instead? I dunno, maybe. But the forced savings aspect is probably good for most Americans that spend what or more than they make each paycheck.

  2. kristine says:

    We always get a fed refund, and a state bill. About 1K net refund. The fed/state incongruency has always perplexed me.

  3. Pat S. says:

    Great points. Rings a bell for me. I’ve caught myself spending my tax refund before I knew how much it would even be too many times in my life. Now, it goes straight to savings.

  4. Kathryn says:

    I think you make a great point, and I do fall into the “don’t give the feds an interest-free loan” camp. However, I don’t think it’s foolish to use your tax refund to “treat” yourself IF you’re debt-free and caught up on important financial goals like saving for retirement. The key, I think, is to spend intentionally and on things/experiences that you really value. E.g., using a refund to pay cash for a nice vacation can be a great learning and memory-making experience for your family.

  5. Paula says:

    This year, we are using our refund to pay down debt we incurred when my husband lost his job last year. The credit card payments alone (from heating bills,car maintenance, health insurance copays, etc) made it hard to have anything left over every month (and we live as cheaply as possible). I can’t tell you how GOOD it felt just to be able to pay off our balance!

    Now, we can take the money that we were spending on the credit cards and transfer that to our savings account every month…

  6. Mine went into savings…where it will stay until I buy my plane ticket to Japan. That’s the side of the coin I want to be on.

    It strikes me as somewhat odd how your consistently bring up your honeymoon trip in a (seemingly) negative light, especially when you consider how you often preach that experiences are far more valuable than Stuff. Life is a limited time offer, and if you don’t take them time (and spend the money) to enjoy it, what are you left with? A big bank account?

    I’m all for living frugal, installing programmable thermostats, driving a paid off car as long as possible, cooking at home, etc., but if you’re only doing all these things just to fatten up a bank account, what’s the point? Financial security? What’s the point of financial security if you’re not enjoying life? (And, I don’t believe that a person needs to spend a lot of money to enjoy life.)

    So, maybe what I’m saying in all this is that despite the regular articles you harken back to the “wasted” money of your honeymoon, you still have those memories, you had fun I’m sure, and I bet Sarah also enjoyed herself exploring a new place with you next to her. It’s sad (to me) that you don’t seem to appreciate this. Money is just money, and no, it can’t buy happiness, but it can certainly help make memorable experiences.

    If travel isn’t your thing, just say so, but remember that not all of us value the same thing (thus making this entire comment hypocritical) and find money spent on travel well worth it, more than a downpayment on a house, for example.

  7. marta says:

    The way I see tax refunds, it’s money I earned legimately so, if I want to fund travel or whatever with it, so be it. It usually goes to savings, because generally I manage to save enough for large expenses out of my take-home pay, but should the need arise, it’d be fine to use my refund for such expenses. I have no debts other than my mortgage, after all. I have to withhold a large portion of my income for taxes and there is no way out of it; the percentage is fixed by law for self-employed people. It means I never owe the IRS and that I always get a considerable refund.

    I’d prefer to have more money each month to save/spend/whatever than a big lump once a year, but that is the law and I can’t change it.

    I also have noticed you seem to routinely bring up your honeymoon trip as a “mistake”, even if you had some nice memories out of it. You seem to equate overseas travel with luxury/spending a lot of money, and not everyone travels the way you did. I have done some long trips (1-2 months) on a fraction of what you spent on your honeymoon alone.

  8. Riki says:

    I just bought my first house yesterday!

    My tax refund will be used for a few essentials now that I’m making the switch from an apartment to a house: lawn mower and other yard stuff, changing the locks, a few gallons of paint, a couple of minor changes to the kitchen, the miscellaneous things I won’t even think of until I move in, etc. Oh, and I’m totally splurging on a fancy light fixture for my bedroom.

    My partner and I have been searching for the right house and getting financially prepared for years. I am going to ENJOY spending this income tax refund.

  9. friend says:

    Steven, I enjoyed your comment so much that I finally went to look at your blog. Looks like I’ll have another fave for my daily reading. No diss to Trent implied; I can appreciate multiple viewpoints.

  10. Sara says:

    It always kind of blows my mind when people talk about how to spend their tax refunds, as though it is some kind of gift or prize. It is your money — money that should have been in your paycheck in the first place! I personally like to get a small refund just because I don’t want to get an unpleasant surprise of owing money, and considering the pathetic interest rate I get from my savings account these days, the lost interest is negligible. If you are using your tax refund to pay off debt (especially high-interest debt like credit cards), however, you would be much better off adjusting your deductions so less tax is taken out, and use the additional money in your paycheck to pay extra on your debt throughout the year.

  11. Vanessa says:

    I’m in a lower tax bracket and usually owe each year. I adjusted my w-4 last year to have more tax taken out, and I still ended up owning $23! Not a big amount, but it feels like a lot when you’re barely getting by as it is.

    It boggles my mind when people get hundreds or even thousands of dollars back in a refund. How do they do it? It is due to homeownership? Is it kids? Marriage? They really can’t be overpaying that much each year, can they?

  12. Kathleen says:

    @11 Vanessa –

    Yup, some of us really ARE overpaying that much each year! My husband and I received a $22,000 refund this year because I hadn’t adjusted our withholding to reflect our annual charitable donations and the obscene amounts of mortgage interest and state tax paid (whoops!).

    Also, if you get large bonuses those bonuses generally have an excessive amount of tax withheld, which you then get back when filing.

  13. Gretchen says:

    Better to get $22K back then to owe $22 K. :)

    Trent’s always talking about going on vacations with his family so I don’t understand the honeymoon thing at all.
    It’s the trip that made your family a family.

  14. Paula says:

    #10, Sara: I understand where you are coming from about refunds. My husband and I had a significant decrease in our income last year due to his job loss, which put us in a lower tax bracket. I work full time and he now has a part time job and goes to college full time to finish his degree. We have a son that we pay daycare for after-school care. This year is the first year we were eligible for some major deductions and that is why we got enough of a refund to pay down debt. I had already adjusted my paycheck years ago to have less taxes taken out…

  15. Melody says:

    Steven and friend – If I remember correctly, Trent was still in pretty extreme debt when they took their honeymoon. I think he’s all for paying for experiences, but when you’re in a lot of debt, that refund may not be best spent going to London. Experiences are important because of the time you spend with someone – not the location.

  16. Vanessa says:

    if you get back $22K, I don’t want to know what you have to earn to generate that much tax.

  17. Julia says:

    All through college, I always got a big refund.
    And I always spent it on car repairs. Since finishing college, my refunds have been less than $10 every year. Now I’m just glad I don’t have to write a big check.

  18. VickiB says:

    The whole refund game makes me sick. Taxes are so convoluted that there is an entire INDUSTRY necessary that we have to PAY to get our own $ back that shouldn’t have been taken in the first place??????? I supported a flat tax when I was poor 20 years ago, and I support it now. Get rid of all of the deductions, the refund game, etc. One amount of sales tax, one amount of income tax.

  19. Telephus44 says:

    I usually aim to break even, but ever since we bought a house we’e had so many changes in our tax situation (DH got new much higher paying job, DH got laid off, DS stopped going to daycare) that I’ve had a hard time estimating it correctly. This year we’re getting back almost $1600, and it’s going into my Roth. If we get something significant back (say, over $1000) we usually spend some on something for the house – AppleTV last year – and the rest goes into savings or debt repayment.

  20. Nicole says:

    It’s April 18 this year, not the 15th. They postponed it because of Emancipation Day. I’m sure you still don’t want to be writing your check at the last minute, but I don’t know how this got overlooked.

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