Democratic presidential nominee Joe Biden released his most recent tax return, for the 2018 tax year, and it said his family received a refund of $22,296. Great news for the Bidens, right?
Not exactly. The fact the Bidens got so much money back means they gave the IRS an interest-free loan of all that cash while also tying up their money so they couldn't access it if they needed it.
And they aren't the only ones. The majority of Americans receive tax refunds and, in 2018, the average refund came in at around $2,881, according to research from The Ascent. While the average taxpayer receives far less than Joe and Jill Biden, anyone who gets a lot of money back from the IRS after filing a return is likely making a big mistake.
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Overpaying the IRS comes at a cost
When the Bidens paid in that extra $22,296 to the IRS, they gave up the chance to do something else with the money (investing it, for example). And that meant forgoing potential returns for a long time.
The money they paid in during the month of January, for example, would not have been returned to them for well over a year since they'd have needed to submit their returns before getting it back. Assuming they overpaid by an equal amount each month throughout the year, they gave the IRS $1,858 in January that, by tax day, could've turned into $1,988 (assuming a 7% annual return on investment). And of course, that $130 in forgone funds wasn't the extent of their losses, as each month they could have invested the extra money they sent the IRS and put their money to work for them instead of receiving no return on investment at all.
Of course, the average person won't get such a large refund. But even if you're getting a smaller one, there's an opportunity cost to overpaying the IRS. In fact, the opportunity cost may be even greater if you could've otherwise used the money to invest in a 401(k) during the year and earned an employer match, or used the money to pay down high-interest debt (like on a credit card), which tends to provide a higher return on investment (ROI) than even investing does.
And while the Bidens earned millions and may not have really missed the money, Americans living paycheck-to-paycheck may face even more grave consequences of overpaying their taxes, as the agency isn't going to give the money back if it's needed during the year. If the funds could've been deposited into an emergency fund instead of being used to overpay taxes, they'd be there for you if you need them.
You can fix your mistake (and so can Joe)
The good news is, neither the Bidens nor the average taxpayer needs to lose access to their money and give an interest-free loan to the IRS. Instead, the best approach to paying taxes is to make sure you're sending in enough money to avoid penalties while avoiding a tax refund.
If you work for an employer that withholds taxes and you're likely to receive a refund, you can adjust your W-4 withholding to change the amount being taken from your checks. If you make quarterly estimated tax payments, you can adjust the amount based on the income earned each quarter so you don't pay in more than is needed. Neither of these steps is complicated, and it ensures you don't end up forgoing interest or trapping money with the IRS that you may very well wish you had well before tax day comes around.
