Nothing is certain except...
Nothing is certain except death and taxes.
Benjamin Franklin knew this statement to be true. Most of us in the accounting profession are wishing for one of these things more than the other, especially this time of year (I give you one guess as to which one). That's right, ladies and germs, it's tax time once again in the United States of America. It's time to gather all your documents, prepare your annual tax returns, and hope to file everything on time to avoid getting in trouble with the big, bad IRS. With that in mind I would like to share some of my personal pet thoughts about filing your taxes. Try not to fall asleep while trying to get through this blog. If we all work really hard we can get through this time of year together.
Tax Preparation Services Don't Find Money
This time of year there are dozens of commercials for tax preparation services claiming to get you larger refunds than the other guy. Don't believe the hype. If a tax return is prepared accurately there is no such thing as a larger refund or a smaller refund. There is just the tax that is due, the amount that has already been paid, and then the remain amount that is owed or the amount to be refunded.
Let me try to give you the most basic example. Imagine you are a single person with no other tax related transactions but the wages you earn from your job. That means at the end of the year you will receive a Form W-2 that contains all your tax information. You don't own a home, you don't contribute to charity, you don't have investments that earn interest. You have a W-2 and that is it. Under this scenario your tax return would look exactly the same no matter who prepares your tax return. A CPA that prepares your return would have the exact same result as a tax preparation service in the nearest strip mall. If you withheld more than you needed to then you will get a refund. If you didn't withhold enough you would owe additional taxes. That result would not change.
I'm not saying that tax preparation services are a bad thing. They can be a helpful and inexpensive way to get tax returns prepared for those of us who don't have terribly complex returns. I just don't want you kindly readers to think that by going to a tax preparation service you will magically get a $10,000 refund that you wouldn't have received by using a CPA or preparing your tax return on your own. These tax preparation services aren't graduates of Hogwarts, they are employees trained to perform some basic tax preparation. If you have a fairly simple filing (you have a job, maybe a few kids, own a home, give some contributions, and that's about it) then these tax preparation companies could be the right choice for you. Just don't go into the process thinking that they will mysteriously find you more money.
Tax Refunds are Not "Found" Money
Every year someone I know will get excited because they have a big tax refund. They shout something like "Yes! Look at all this free money!" or "Yes! I'm rich!" or "Yes! Now I can afford that butt lift I've always wanted!" People act as if a tax refund is a gift from the government thanking them for being good citizens. Well, I'm here to tell you that it is not. A tax refund is simply the government giving back the money that was rightfully yours from the beginning. A tax refund is a is the government returning the principle of your interest-free loan. I know that last sentence only makes sense to those who work in finance so let me try to explain.
For this example, try to think of the IRS as a bank. We will call it IRS Bank (because I'm the creative type I can always come up with the best fictional names). Every month you take part of your paycheck and deposit it into an account at IRS Bank. IRS Bank utilizes the funds you deposited into this account to pay your bills (water, electric, utility, etc) and then any amount left over is savings. You, as the owner of the account at the IRS Bank, are paid interest by IRS Bank because you use IRS Bank. Sure, the interest rates in this account aren't very high but a little interest income is still a little interest income. At the end of the year you take a look at your account at IRS Bank and calculate that you have put in more than you need to pay all your bills. That's no big deal because IRS Bank was paying you interest in the additional funds so you are making your money work for you. IRS Bank either lets you take back all the money in the account you didn't use that year or you can let the money sit in the account to use for next year's bills. If you take the money back you won't earn the interest but you'll have the cash. If you let the money stay in the account you will earn a little bit of interest. The choice is yours.
This is a vary basic example of how paying taxes works. Each month you have money withheld from your paycheck that goes to the IRS. The IRS uses your money to pay bills (military, Congress, the various Executive Branch departments, FBI, CIA, etc., etc., etc.) and then at the end of the year you use the Form 1040 to calculate your share of the bills. If you paid in too much the IRS gives you your money back. If you didn't pay enough you have to pay the IRS. The difference between IRS Bank and the IRS is that the IRS does not pay you interest on the amount you overpaid. By overpaying your taxes you just gave the government an interest-free loan. The money you put into IRS Bank gave you some, albeit very small, interest income. The money you put into the IRS gave you nothing at all.
A tax refund isn't found money. It is your money that you let the government use during the year. You don't get some sort of bonus or a pat on the back for getting a refund from the government. All you get back is your own money that you should have had in your bank account earning interest for you instead of sitting in the governments account earning interest for the government. In my opinion, you shouldn't be getting a refund from your taxes. A refund means that you paid to much to the government during the year and provided the government with an interest-free loan.
The flip side of that coin is that if you don't pay enough the government can charge you penalties and interest on what you didn't pay. That's right, if the government has held more of your money during the year than you owed you will not receive in interest in return but simply a refund of your money. However, if you don't pay the government enough you may be subject to penalties and interest for not paying your share during the year. I'm not here to debate whether this is right or wrong (that is a political argument I don't want to get into right now) but that is the way it is.
So what should you do? The goal is to get as close to paying exactly what you owe during the year. The perfect tax return is the one where you don't owe any money and you don't have a refund. This means you kept the money you should have kept and didn't provide the government with an interest-free loan. Getting a small refund or paying a small amount at the end of the year are okay because estimating the perfect amount to withhold from your paycheck or to pay in estimated taxes is challenging even for the experts. The point I'm trying to make is don't think that your $3,000 tax refund is free money that you never had before. That $3,000 was yours from the beginning and if you had put that $3,000 into a certificate of deposit that earned 1.5% during the year you would have taken home $3,045 instead of the $3,000 from the IRS. Sure, it isn't much, but $45 is still $45.
Don't Wait...File Your Taxes
Your W-2 is required to be provided by January 31st. Your personal tax return is typically do by April 15th. That gives you two and a half months to prepare your taxes and get them filed. Why are you waiting? Are you scared? Are you overwhelmed? Are you just procrastinating because looking at all the boxes and numbers on your Form 1040 makes your head want to explode?
These are all valid reasons but I'm recommending you buckle down and get your taxes filed early. The earlier you file your taxes the sooner your get your refund. The longer you wait the more the stress will come down on you. The longer you wait the more tax returns pile up a tax accountant's desk and the more likely your tax return will not get completed. As much as an accountant works during tax season there is still a limited number of hours in a day so some of these tax returns will have to be extended.
I wish you all good luck in completing your tax returns and filing your taxes. If you have questions let me know and I'll do my best to help. Good luck.
PERSONAL DISCLAIMER: All the statement contained in this blog are my own opinion and do not necessarily represent the opinions of my employer, the IRS, or anyone other than me.
CIRCULAR 230 DISCLOSURE: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained herein (including any attachments) is not intended or written to be used, and cannot be used by the taxpayer for the purpose of (a) avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code or by any other tax authority; or (b) promoting, marketing, or recommending to another party any tax-related matter addressed herein. We provide this disclosure to assure compliance with the standards of professional practice, pursuant to which certain tax advice must satisfy requirements as to form and substance.