Getting Money Back from Uncle Sam

by | Mar 27, 2009 | Cash Flow, Weekly Column

uncle-sam-hat.jpgAt a recent quarterly review, one of my clients told me wryly, “Well, I’ve discovered the silver lining to all the losses in my investments. I just had my taxes done, and I’m going to get a refund. I haven’t done that in years.”

Investment losses offset capital gains, plus $3000 of ordinary income, and the losses carry over from year to year. As a result, many of those whose portfolios had heavy losses in 2008 will see lower taxes over the next few years.

A tax refund of a few thousand dollars, of course, doesn’t do much to offset portfolio losses of tens of thousands of dollars. Still, there’s something about the idea of getting a sizeable check that makes us feel as if we’re getting a windfall. It may feel like “found money” that we should be able to use any way we wish.

If you’ll be getting a tax refund this year, what should you do with it? A column by Kimberly Lankford in the March 19 online issue of Kiplinger’s Personal Finance offered these suggestions:

1. Build your emergency fund.

2. Pay down high-interest debt.

3. Rebuild your retirement savings; a refund received before April 15 could still go into an IRA for 2008.529-plan.jpg

4. If you have already taken care of numbers one through three, put the money into 529 plans for your kids’ college education.

5. If the first four ideas are covered, and if your kids have earned income, open Roth IRAs for them.

These ideas make sense, though I would emphasize building your own emergency fund and providing for your own financial health before setting money aside for college for the kids. I would also make a couple of additional suggestions.

First of all, rather than blindly following someone else’s recommendations, be sure you use your tax refund in a way that is tailored to fit your own circumstances. If your job situation is shaky, you’ll almost certainly want to add that refund to your emergency fund. If you have an uncomfortable amount of credit card debt, putting the refund toward that debt might do a lot to reduce your financial stress. If your income seems secure, you have little or no debt, and you already follow a spending and savings plan, maybe a trip to Hawaii or a new big-screen TV would be a perfectly appropriate use of your tax refund.

Second, take a look at how much you’re paying in throughout the year, both in withholding and estimated tax payments. If your tax bill is likely to be lower over the next few years, adjust your withholding and estimated tax payments accordingly.

The last thing you want is to consistently get a sizeable tax refund. It may feel like “found money,” but it actually is your repayment from the government of an interest-free loan you’ve made to Uncle Sam.

Money you overpay in taxes isn’t doing any work for you. If you put that money into an IRA instead, you may see it appreciate and gain some tax benefits, as well. Even putting it into a bank savings account will at least earn you a little bit of interest.

tax-return.jpgEven if you usually prepare your own tax returns, this year may be a good time to consult an accountant. By making sure you are reporting any investment losses correctly and taking advantage of new tax laws, professional tax preparers may well save you more than enough to cover their fees. Make sure you aren’t paying more in taxes than you owe.

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