Taxes are complicated, so it's no wonder mistakes are common. Sometimes, these mistakes occur when you actually file -- perhaps because you add some numbers incorrectly or you forget to claim a deduction.
But in other situations, the mistake happens even before you've submitted your 1040 form. In fact, one of the single most common tax mistakes that Americans make affects them all year long.
That mistake: Getting a tax refund.
The IRS issues billions of dollars in refunds every year
According to IRS data, the IRS issued almost $464 billion in tax refunds in fiscal year 2018. That's a ton of money lent to the IRS interest-free by hard-working Americans.
Americans gave the IRS this money by overpaying what they owe on taxes throughout the year. This could happen because you don't tell your employer to withhold the proper amount from your paycheck. Or it could happen if you send in estimated tax payments that are higher than they need to be.
Unfortunately, many Americans don't even realize that overpaying their taxes is a problem. In fact, it's common to be excited about getting a refund.
But there are several reasons why it's a really bad idea to give the IRS all this extra money and then wait to get it back.
Why is overpaying your taxes a mistake?
While a refund may seem exciting, it's just your own money coming back to you after a delay. And sometimes it's a long wait to get your money returned. Any money overpaid in January, for example, won't come back to you for more than a year.
All this money is tied up and you can't do anything else with it. This can have big opportunity costs.
- If you have a financial emergency, the money won't be there for you and you might have to borrow.
- If you want to take a vacation, you may end up borrowing to pay for it, instead of being able to pay cash with money you could've saved by not overpaying your taxes.
- If you're in debt, you won't have the money to pay extra to your creditors. Even if you apply your tax refund to the debt, you'll pay interest for longer, so you'll end up paying more than if you'd been sending in extra payments all along.
- If you want to invest, you'll miss out on returns you could've earned during the time the IRS had your money.
You can avoid making this common mistake
To make sure you don't end up getting a refund every year, consider adjusting your withholding with your employer by updating your W-4 form so the correct amount is withheld from your paychecks. Or recalculate the amount you pay in estimated taxes, so you're paying in what you owe, but not hundreds or thousands of dollars extra.
You work hard for your money, and you should be able to make the most of it. Giving an interest-free loan to the IRS doesn't allow you to do that.