Wednesday, May 13, 2009

IS IT REALLY BETTER TO GIVE THAN TO RECEIVE?

Let’s face it – everyone loves, and wants, a tax refund!

And as a tax preparer, very few things give me more pleasure, at least during the tax filing season, then writing in the explanatory email or memo that precedes or accompanies a finished return, “Your Uncle Sam owes you tons of money this year!”

It is certainly better than beginning with “Oi vey!” or “Now don’t shoot the messenger”.

If everyone loves a refund it only follows that everyone hates paying their “uncles”.

For some the hatred is more deep seated than others. Some of my clients really hate to pay additional taxes with a passion. In their mind they paid more than enough during the year. They would rather get a refund of $1.00 than pay anything to Sam or Jon or Dave (over the years I have on occasion had a return with a refund of only $1.00 – in the old days of the NYC payroll tax if your refund was $1.00 you had to write a letter to the City and request they send you the $1.00).

However, from a strictly financial point of view, when it comes to taxes it is truly “better to give than to receive”. A tax refund means that you have made an interest-free loan to the federal, or state, government.

If you owe Sam, or your state, a balance due on your return that, by way of the various “safe harbor” rules, avoids a penalty assessment for “underpayment of estimated tax” it is you who have received an interest-free loan from the government. You have had full use of your money during the year!

Quite a few of my clients receive rather substantial refunds on purpose, and have been doing so for years. It is a form or “forced savings” - somewhat like a vacation club. They plan to use the refund to pay for their annual family vacation, or to make needed home improvements, or pay for college, or pay off credit card debt.

I, and they, know full well that if they had an extra $100-$200 in their pockets each week they would spend it – and not necessarily wisely.

And, considering today’s interest rates on temporary investments, just what would they earn on the money if they invested it each paycheck instead of giving it to Sam or Jon or Dave for “safekeeping”?
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$10,000 invested at 1½% evenly throughout the year would earn about $75.00 in interest. As I said when reacting to BO’s $10-$13 per week in Making Work Pay Credit advance – “big whoop”! Even at 2% or 2½ % the earnings are certainly not impressive.

Back in “the day” when ordinary passbook savings accounts paid 5.25%, and short-term CDs paid more, the earnings was worthwhile – and I would recommend to clients that they have the excess withholding automatically deposited in a credit union account so it would not pass through their hands.

And during the Carter years, when interest rates even on money market accounts were double-digit, a refund was truly a sin.

But today this lost interest is a small price to pay for removing the temptation of having the money available for drawing upon during the year.
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Wait - here’s a thought. Have you accumulated excessive high-interest credit card debt? Using the $100-$200 per week to pay down such debt is like getting a double-digit return on your money and certainly worthwhile. But, just like with using home equity borrowing to pay down credit card debt, this idea only pays if you do not turn around and build the credit card debt back up again.
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So while I do, on occasion, point out that a large refund = making an interest free loan to the government, I do fully understand why clients choose to do so, and even encourage the practice.

TTFN

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