For many Americans, it's that dreaded time of the year: tax season.
Preparing one's taxes simply isn't something most Americans (including yours truly) enjoys -- and for good reason. According to the Tax Foundation, there are more than 10 million words in the U.S. tax code, with an average of 144,500 words being added every year since 1955. In terms of compliance, the Internal Revenue Service estimates that taxpayers spent 8.9 billion hours complying with federal tax laws in 2016.
Taxes are growing more complicated by the year, and having to revisit our previous year's finances simply isn't fun, even if we now have the luxury of tax software that'll walk us through the tax preparation process.
A fat refund check is a double-edged sword
On the other hand, most Americans have a "prize" waiting for them at the end of the arduous tax preparation process. According to IRS data from 2014, of the 149.7 million tax returns it processed, 109.5 million taxpayers received a federal refund check, with an average refund of $2,792. This means 73% of all tax filers got money back. Federal tax returns can be put to good use, such as paying down credit card debt, building an emergency fund, or boosting a retirement account.
However, there's another side to the tax refund story. Another angle to consider is that 109.5 million people allowed the federal government to hang onto an average of $2,792 of their money for months, or perhaps longer than a year, and they didn't earn a single cent in interest on their cash. For impulsive spenders, a fat refund check could be a smart means of saving. For the bulk of taxpayers, though, I'd presume that allowing the federal government to hang onto your income without any interest isn't a good idea.
For the 2016 tax year (which is what you'll be prepping your taxes for between now and April 15, 2017), more than 150 million individual income tax filings are expected. Assuming the 73% refund rate is consistent, it means that, conservatively, 110 million people will receive a check this year from Uncle Sam.
This quick fix could give taxpayers a nice raise
But what if I told you that these 110 million taxpayers could give themselves a raise, and it would probably take less than a minute of their time?
The federal government removes federal income tax from your paycheck based on the preferences you decide when filling out a W-4 tax withholding form with your employer. You don't have any control over what comes out of your wages for FICA taxes (Social Security and Medicare payroll taxes), but you do have full control over what percentage of your income is removed out of your weekly, bi-weekly, or monthly paycheck by the IRS.
Now here's the interesting thing with a W-4: They can be updated as often as you'd like. If a major life event has occurred, such as a wedding, divorce, or the birth of a new baby, you can adjust your W-4 to reflect the need to take less income tax, or more, out of your paycheck.
The purpose of regularly adjusting your W-4 is simple: You'll receive more of the money you're owed up front with each and every paycheck, with the ultimate goal of moving your year-end tax bill/refund to as close to $0 as possible. In a way, you'll be giving yourself a raise.
Now I know what some of you might be thinking: "That's not a raise! I'd be getting the same amount back come April of the following year as I'd be receiving in paychecks, albeit over a 12-month period." Thinking this is partially right, but it leaves out a key component to the story.
Being able to get your money in the form of a higher paycheck between January and December of the current year as opposed to April of the following year could allow you to pay off your debts faster. Remember, debt accrues interest, meaning you'll be saving money if you can whittle down your principal now as opposed to letting it grow into a larger debt pile by the following April. The same is true of investing. If you can invest your money consistently throughout the year as opposed to waiting until April of the following year, you would presumably have a head start. In other words, you'd be giving yourself a raise.
Adjusting your W-4 takes just a matter of moments with your company's human resources department, but the impact it can have on your pocketbook can last throughout the year. If you're often due a big federal tax refund, strongly consider adjusting your tax withholding now and giving yourself a raise with each remaining paycheck in 2017.