Everyone likes to get as big of a tax refund as they can. Changes in tax laws over time can affect how large typical refunds are, but year in and year out, millions of Americans count on getting a sizable refund check soon after they file their tax returns for the year.
It's important to understand that the real key to tax success is minimizing your total tax bill. That includes not only what, if anything, you owe when you file your return, but also what you have withheld from your pay over the course of the year. Below, we'll talk more about how tax refunds work, some key deadlines you need to know about, and some of the most popular ways you can make sure you get every penny you deserve back from the tax man.
Why do we get tax refunds?
The tax system could function just fine by simply having people pay their taxes when they came due, writing a big check to the federal government to cover the entire year's tax liability. Instead, the government decided to start withholding federal tax from each paycheck. That way, employees would effectively cover a portion of their yearly tax bill every time they got paid.
If withholding were perfect, then it would exactly match your eventual tax liability, and there'd be no need for a refund. However, the government often withholds more than it needs to in order to make certain it covers what you owe. When that happens, the government has to pay you back -- and that's when it sends you a tax refund.
There are a couple of reasons the government made that decision. First, it doesn't want to have to wait until April 15 of the following year to collect taxes on the income paid in a given year. Instead, government officials ideally want to see relatively constant streams of tax revenue come in throughout the year, allowing the government to match up the money it pays out to employees, contractors, and other parties with the money it brings in through taxation.
Also, the government realizes that many people don't have the financial discipline to save up over the course of the year to pay a huge tax bill when they file their returns. All too often, people in this situation can't pay their taxes in full, and that can lead to penalties, interest, and the added hassle of having to negotiate with the IRS to come up with longer-term payment plans.
How does the government pay tax refunds?
There are two ways you can receive a refund:
- Request that the government send you a physical paper check. You can deposit it to your bank account or cash it at any financial institution that offers check-cashing services.
- Have the refund deposited directly into a bank account through an electronic funds transfer. This method of getting a refund is faster and more secure, but it requires that you have a personal bank account.
For those who don't have access to banking services, a paper refund check is the only viable option -- even though it can take a bit longer.
Who qualifies for a tax refund?
In order to get a refund, the following things have to be true:
- You have to have had more money withheld for taxes or paid more in estimated tax payments for the year than your actual tax liability, or you have to have earned refundable tax credits.
- You have to file a tax return claiming your refund amount.
- You must file that tax return within three years of the original due date of the return.
That last point is an important one. For instance, say you never bothered filing a tax return for 2015 because you knew you didn't owe any tax. When you look again, you see that you'd actually qualify to get a refund. The due date for your 2015 return was April 15, 2016. That means you have three years beyond that date -- or April 15, 2019 -- to file a return and claim that refund. Once you miss that deadline, you can't go back and get that refund check -- even if you deserved to get it.
10 refund-boosting techniques to follow
With all of that as background, it's time to look at things you can do to boost the size of your refund. Here are 10 of the most popular ways to max out a refund:
- Claim the best filing status you can.
- Use the earned income tax credit if you qualify.
- Many parents can use the child tax credit.
- Be smart about itemizing or using the standard deduction.
- Use the American Opportunity tax credit if you or your child is in college.
- Don't forget to include all of your withheld taxes on your return.
- Take advantage of tax-favored retirement accounts.
- Use a health savings account if you can.
- Defer taxable income whenever possible.
- Think twice before taking withdrawals from retirement accounts.
We'll look at each of these in turn below.
1. Pick the best tax filing status
At the top of your tax return, you have to indicate your tax filing status: that is, whether you're filing as a single person, head of household, a joint return for married couples, or a separate filing for one spouse. In addition, certain surviving spouses are eligible to claim qualified widow or widower status for a period of time after the death of their spouse.
Different tax filing statuses offer different income brackets at which tax rates apply, and choosing one over another can let you have more taxable income taxed at lower rates. For instance, being head of household -- which usually involves supporting a child or other qualifying dependent -- offered a standard deduction of $18,000 in 2018, compared to $12,000 for someone filing as a single taxpayer. Tax brackets are also about 50% higher in most cases. Also, with tax reform, most of the so-called marriage penalty has disappeared, so getting married can often lead to a lower total tax bill. It's worth looking into your situation to see whether choosing a different tax filing status can give you added benefits -- and a bigger refund.
2. The earned income credit
The earned income tax credit is available to low- and middle-income taxpayers, with the largest credits reserved for those who have children. A credit of as much as $6,431 is available for the 2018 tax year for those with three or more children, while smaller credits of $5,716 for those with two children or $3,461 for those with one child apply.
To qualify for the earned income credit, you have to earn income from a job or self-run business, and your overall income must fall within limits depending on family size and filing status. The best thing about the earned income credit is that it's an example of a refundable credit, which means even if you don't otherwise owe anything in taxes, you can still claim a refund check for the full amount of your earned income credit. That makes the credit worth pursuing.
3. The child tax credit
The child tax credit is one of the simplest tax provisions in the current laws. If you have a child who's younger than 17, then you qualify for up to $2,000 in tax credits per child. Moreover, a portion of that money can be refundable through the use of the additional child tax credit.
There are income limits on the child tax credit, but they were moved dramatically higher for the 2018 tax year. Now, single taxpayers can have income of $250,000, and $500,000 for joint filers, before the credit starts to phase out. That's good news for parents, and it means more people than ever before will qualify for the credit and potentially see their refunds grow.
4. Itemizing vs. the standard deduction
Taxpayers have always had a choice to try to maximize their tax refunds. You can claim the standard deduction, which is a simple way to get a baseline reduction of your taxable income. You can instead itemize your deductions, with the goal of finding a greater amount of eligible deductions that you can use to cut your tax bill even further.
Your best bet is almost always to do whatever will result in the larger deduction amount. However, tax reform nearly doubled the size of the standard deduction, while also putting new limits on some itemized deductions. As a result, more people will find that the standard deduction is their best move for the 2018 tax year, unlike in previous years.
5. American Opportunity tax credit
There are many tax breaks for college education, but the American Opportunity tax credit is the best. This credit lets you claim 100% of the first $2,000 of eligible college expenses against your tax bill for each of the first four years of undergraduate education, along with 25% of the next $2,000. That provides a maximum credit of $2,500 per year, or $10,000 total for a four-year education.
Income limitations exist on the credit, but they're relatively high, with maximum income of $80,000 for single filers or $160,000 for joint returns to claim the full credit. Not all of the credit is refundable, but up to $1,000 per year is. Given the rising cost of tuition, required course materials, and associated fees, this credit can help you get a bigger refund to help pay your share of those school expenses.
6. Previously withheld tax
The worst thing you can do is not take credit for the money you had withheld for taxes. Form W-2 will have the amounts you had taken out of your paychecks, but there are some other situations in which you might have had taxes withheld.
For instance, if you received income from a pension plan or a retirement account, your financial provider or former employer might have withheld money toward taxes. You'll be able to see whether that's the case by looking at the Form 1099-R that you'll receive from whoever paid out those pension payments or retirement plan benefits, as there's a box that clearly indicates any taxes withheld. By claiming those amounts on the proper spot on your 1040 form, you won't leave any money on the table.
7. Tax-favored retirement accounts
One time-honored way of cutting your taxes at the last minute involves making traditional IRA contributions. Using these retirement accounts can lead to an immediate reduction in your taxable income, thereby boosting your refund. The best thing about traditional IRA contributions is that you can make them now, after the end of the tax year, and still get a valuable tax break, as long as you do so by the final deadline of April 15.
In addition to traditional IRAs, 401(k) contributions can reduce your taxable income as well. However, those contributions have to be made during the calendar year in question, so any contributions you make now won't be available for use on your 2018 tax return. Even so, tax-favored retirement accounts have the added benefit of letting you save for retirement without having to pay any taxes on investment income or gains while the money's inside the account, and that's a tax break that can add up to big savings over the long run.
8. Health savings accounts
Health savings accounts are available to anyone who has health insurance coverage that includes high deductible amounts that meet federal guidelines. Those who qualify for HSAs can set aside up to $3,450 in 2018 for a policy that covers just a single person, or $6,850 for a policy that covers your entire family. Additional catch-up contributions of $1,000 are available if you're 55 or older.
Like traditional IRAs, HSA contributions are available until the due date of the tax return for the year in question. In the case of 2018, that gives you until April 15, 2019 to make an HSA contribution. Again, though, your health insurance coverage has to have met the high-deductible standards in order to qualify, so it's not as though you can go back and retroactively change your health insurance policy to match up with those standards.
9. Push taxable income onto next year's return
The goal of anyone trying to maximize their refund is to have as little taxable income and as many deductions and credits as possible. Most people have only limited control over the timing of their income, but some can maneuver to shift income forward into the following year in order to cut taxes this year. If you can move income from December to January, then you get almost a whole extra year to pay the resulting tax bill.
Of course, that's only true when tax rates are the same from year to year. Tax reform made moving taxable income from 2017 to 2018 even more lucrative than usual, because the rates on 2018 income are generally much lower. However, if future tax hikes come, then it might be smart during that year only to go ahead and take income and pay low tax rates on it while you can.
10. Avoid withdrawals from retirement accounts
Along the same lines as the last point, one thing that can often result in unexpected taxable income is taking money out of retirement accounts. Traditional IRAs and 401(k) accounts offer tax-deferred growth for as long as the money remains within the account, but when it comes time to start taking withdrawals to cover your living expenses in retirement, then that's when the tax bill comes due. Taking distributions from those accounts requires you to include the withdrawn amount as taxable income in the year of the withdrawal.
Accordingly, you should be careful about taking withdrawals from retirement accounts to make sure the tax impact won't be too painful. In some cases, if you have a combination of traditional and Roth IRAs or 401(k) accounts, then you can balance withdrawals from regular and Roth sources in order to moderate the impact on your taxable income. Unlike regular IRAs and 401(k)s, Roth withdrawals generally aren't included as income on your tax return. When you need your hard-earned retirement nest egg to make ends meet, making sure you'll be able to take the money you need without sabotaging your tax refund is especially important.
The better alternative to a larger tax refund
All of the tactics discussed above can help you boost the size of your refund. However, they also make it possible for you to do something else that you might like better: get larger paychecks throughout the year.
People love to get tax refunds because they feel like free money they didn't anticipate. But a tax refund represents extra money that you paid to the IRS that you didn't actually have to pay. Put another way, because you had more tax withheld from your paychecks during the year than you needed, you gave up the chance to use that money sooner. Instead, you had to wait until the IRS got around to paying you back.
There's nothing terribly wrong with making these tax-saving moves and then waiting until the following year to reap the rewards with a bigger refund after you file your return. However, you can instead adjust your tax withholding in order to tap into those tax savings right now -- and get bigger paychecks as a result.
Be smart about your tax refund
Getting a tax refund really means you paid too much money to the IRS through withholding and other payments. Even so, you should still always try to get as big of a refund as possible -- as long as you do so by looking for savvy ways to cut your overall tax bill.