Is it Better to Receive a Tax Refund or Owe the IRS?

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Last updated on August 27, 2022 Comments: 33

When you work for a company that manages its payroll properly, federal and state taxes are withheld every pay period. The companies estimate your total tax bill based on your annual salary and divide that amount by the number of pay periods within the year. They get some help from the W-4 form you filled out when you were hired, which includes important tax information like your filing status and the number of claimed dependents.

This calculation almost never works out well. Either you don’t pay enough tax throughout the year, thanks to, among other possibilities, income you receive unknown to your company, or you pay more than you owe, thanks to deductions unknown to your company.

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This underpayment or overpayment results in tax due to the IRS or a refund due to you. These differences are reconciled when you file your taxes.

You know all this, but the basics bear repeating in order to pose this question. Since it’s almost impossible to predict to the penny how much tax you will owe, is it better to err on the side of black or red? That is, is it better to owe money to the IRS or allow the IRS to owe money to you?

Owing money to the IRS for underpayment of taxes

If you have to write a check when you file your taxes, it means you got to use or keep and earn interest on the government’s money throughout the year. That’s not a bad thing; it’s like an interest-free loan. However, if you don’t plan, you could end up owing money that you don’t have, causing a major cash flow problem. If you underpay significantly, you could end up owing penalty fees as well.

Expecting a refund from the IRS for overpayment of taxes

If you receive a refund, you gave the government an interest-free loan throughout the year. Politicians will be happy to take your money to fund various programs while you work, but it doesn’t have to be that way. By not keeping money that is rightfully “yours,” you lost the opportunity to invest and earn interest on that cash. However, there is a psychological advantage to receiving a check from the government.

Not only that, but overpayment of taxes can act as a “forced savings plan,” albeit not a very good one. The forced savings can be beneficial to anyone who struggles with spending less than they earn.

I would prefer to owe the government money when it comes time to reconcile tax liability every year. The benefits of using the government’s money for free outweigh the benefits of letting the government hold my money, at least for me. I think most Consumerism Commentary readers, who probably have no need for a “forced savings plan,” would agree. But I’d like to hear other opinions, so feel free to share your thoughts.

This post is a part of the MoneyBlogNetwork Group Writing Project focusing on taxes. Here are the contributions to the writing project so far: The Value of Doing Your Own Taxes (Five Cent Nickel); My Best Piece of Tax Advice (Free Money Finance); Mr. Lawyer and Mr. Accountant Chat About Taxes (Get Rich Slowly); A tax tip from my pastor (Mighty Bargain Hunter); A Taxing Situation – My Biggest Financial Regret (No Credit Needed); Certainties: Death, Taxes, And Change (Wise Bread).

Article comments

33 comments
Anonymous says:

I want more money In my check. I don’t care about the end of the year.I need it now.I thought there was a poverty level and if you were on it you didn’t have to file.

Stephanie Colestock says:

If you are single and under 65 years old, you only have to file if you make more than $10,350 in a year. If you’re married or over 65, this number varies slightly, but you are correct: not everyone is required to file.

–Stephanie
stephanie@doughroller.net

Anonymous says:

I keep hearing about penalties and fees for owing too much, but no clear definition on when these apply.

My wife and I make just a bit over 63k a year and we usually pay 3k a year for federal taxes. We use TurboTax for our taxes, but no mention of any penalties or fees. Been skipping over the comments, but no mention of specific rules from what I can see. I’m sure there is though. Any help would be appreciated.

Anonymous says:

I made $7000 less last year due to a 20% pay-cut. Normally every preceding year I had to pay the IRS between $140 and $180. This year i had to pay the I.R.S. $488! How is it that I made much less money but ended up paying more to the I.R.S.?????

Luke Landes says:

You haven’t offered nearly enough information for anyone to evaluate your situation or answer your question. Your total tax bill isn’t what you owe when you file in April. Perhaps you paid less income tax throughout the year than you should have, and now have to make up the difference. Perhaps your withholding was incorrect. Perhaps you no longer qualify for certain deductions you qualified for last year.

Anonymous says:

Well,what I meant is that I usually end up owing the IRS but I thought that since I made $7,000 less last year that I would owe them less. In previous years I would usually have to pay between $140 and $180. However, this time I ended up having to pay $488 despite the big pay-cut. Nothing has changed regarding my filing status which is why this is so confusing.

Anonymous says:

I don’t understand Thomas’ comment. It is not better to owe the government. I can get interest in my checking and savings account and I get no interest by letting it sit in a government account. Not to mention that the government is broke so there is a chance they will delay giving it back like they did in California.

Anonymous says:

Then every working taxpayer should close out their savings account and checking account because when a deposit is made they are loaning the bank interest free money. I disagree that everyone seems to say it’s better to owe the government.

Anonymous says:

I prefer to get a refund, since I am retired, divorced, and only work part-time. The price of gasoline, food, and everything else keeps increasing, yet my retirement check remains the same. The eight year old car that I drive is in good shape, but it will not last forever.

When I re-joined the world of singles after a fourteen year marriage, I had to pay extra taxes, because I was told that my marital status changed in the middle of a tax year, which placed me in a different tax bracket. Meaning what – that singles are taxed higher than married people?

However, since I work part-time in an intermittent capacity (maybe nine days out of the month), that my salary was added to my retirement income, and I was charged not only last year ($305), but this year as well ($151). I do not understand this kind of rationale, and it was not explained to me in a way I can understand it. I was advised, last year, to have my employer to change my W-4 to reflect zero. I discovered that it was not done, and I am handling that again. I am not old enough to receive Social Security, yet I had enough years served, to be able to retire.

It is my opinion, that I am being overcharged. It appears that I am being penalized because

a)I am divorced, with no children or grand children
b)I am retired
c)I have the drive to go out and work
d)I have no desire to go on welfare, and be a burden to society
e)my retirement check is not enough to live on.

For all the blood I shed getting to retirement, I deserve to be able to live comfortably, without fear of not being able to keep a roof over my head. Can someone please help me to figure out and to understand why I have to pay so much in taxes?

Luke Landes says:

G.E.: Thanks.

These are the links G.E. refers to, which he could have left in the comment above:

Turbo Tax’s Tax Tools
H&R Block Withholding Calculator
IRS Publication 919 [pdf]

Anonymous says:

This past year I ended up getting about $170 from the feds, and owing $70 to the state, which was absolutely ideal. Some of your readers have been interested in withholding allowance calculators. I have links to the Turbotax and H&R Block calculators in this article: link

Anonymous says:

I’m getting a big refund from Federal and State this year but I’d rather owe them a little at the end. Ideally, between $500 and $1,500. The extra cash flow would have helped us out in 2007. I am making sure that we lower our withholdings for this year for both state and federal. This will allow me to increase contributions to my company’s 403b and even further lower my taxes!

Anonymous says:

Refunds=a loan to the Government with no interest does not apply to everyone, I have a superintendent in my building, we were talking and he mentioned after hes done with his shift, he’ll head over to H&R to get his taxes done, but first the bank to withdraw money to pay the fee they charge, and I asked him about his tax situation to see if it was complicated, he said no, just 1 W-2, and 2 dependents his kids, wife does not work, so I said to him I’m no expert, but I do my own taxes, and since your situation is not complicated I can do yours for you, this way you don’t have to pay H&R, he was grateful to have saved that money, and even more grateful 2 days later, when I showed him he was going to be receiving over $7000, now they call this a refund, but he did not pay anywhere near $7000 in taxes during the year, this was free money he was getting, and this was done by taking the standard deduction.

Anonymous says:

Correction. That one just went down today. Was working Saterday

Anonymous says:

The IRS just moved the withholding calculator on their site. This one works now.

http://www.irs.gov/individuals/page/0,,id=14806,00.html

Luke Landes says:

Bryan: This calculator may help you out.

Anonymous says:

@Bryan – We had the same experience when we got married. I had always heard that married couples get tax breaks, but we both went from getting refunds to owing about $3500. The next year we owed $3000, even after claiming 0 plus $50 a week out my paycheck!!!!

Things are much better now with kids and mortgage interest, but we also now pay quarterly.

If we owe less than $2000 at the end of the year I am ecstatic. We have about $5000 saved for taxes, so anything left after paying goes into circulation!

Anonymous says:

Earlier this year I adjusted my witholding because I didn’t want to give the government an interest-free loan. But given that this is my first year with a real post-college job and filing my own taxes, that I didn’t have the info required for that witholding calculator. Come December I started worrying that I was going to owe too much, and adjusted it back to compensate. Hopefully I didn’t mess things up too bad, but I’ll find out when I do my taxes this week.

Anonymous says:

I prefer to owe just a tiny bit.

But, that being said, because my own income is so variable, I tend to overwithhold “just in case”. So I end up getting a small refund.

The only year we got a very large refund was the year we had my daughter. She was born at the end of October, and we didn’t adjust withholding until after she was born. Better to get $2000 back (in our eyes) than have underwithheld and something happened to her in utero or delivery and she wasn’t okay. But she came out alive and well so she was indeed a tax deduction that year.

Anonymous says:

It turns out that filling out the W-4 form if you’re part of a working couple needs a lot more finesse than if you’re working just for yourself.

I didn’t know this, and didn’t read all the “fine print”, so we were very shocked to learn that we now owe the IRS $6,000, which we’ll probably be paying off for two or three years.

The IRS has a withholding calculator that is theoretically useful. So far, it’s been unavailable for the last week, so I haven’t been able to try it out.

If you know of a similar calculator that exists, please link to it!

Anonymous says:

It really depends.

This year, I’ll get back a nice refund, as has been the pattern for the last 2 or 3 years. Now, that’s not for lack of planning. I make sure that as little is withheld as possible. However, investment losses, charitable contributions and business expenses have ridden to my rescue recently.

My financial plan is fine with receiving no money back at the end of the year. I do the high savings yield arbitrage with the non-withheld funds. I may only collect a few hundred in interes on that money (which is also taxable) but its in my control. I am fully prepared, every year, to pay the IRS. I just haven’t needed to recently, due to other aspects of my financial life. It really is gravy to get the refund based on my efforts to either further enrich myself or help others.

I think under anything approximating “normal” conditions, planning for a small refund makes the most sense. Overmanaging this process is really not an effective use of one’s time, methinks. However, I think if you do thinks well, you end up in the situation I have, where it doesn’t matter very much. My plan can accomodate not getting a refund, or even owing, due to how I generally manage the money that would otherwise be sent to the IRS by my employer. However, those offsetting deductions are a reminder that even though my plan is solid, my other efforts pay off in certain ways, even when they don’t necessarily pay. (I mean, over 10K in investment losses means 3+ years of carryover deductions. Various business expenses that weren’t reimbursed.)

Hopefully that makes sense.

Anonymous says:

I’m in the same boat as That One Caveman, in a perfect world i’d get a small amount back at the end of the year.

It’s a little somethin’ somethin’ that wasn’t accounted for (on purpose, not that you even COULD account for as this post shows), but not TOO much where you could have invested it the entire time.

Having recently purchased my first house, i tried to get as close as break even as i could. I changed my claims from 1 to 6 i believe, but still no luck. At least, however, it was a freakin’ awesome surprise! Instead of the $500 or so i was planning on, i received a whopping $3800 🙂

Sure i did the math wrong, but for giving it a shot for my first time, i’m def. not complaining…i could have made an opposite mistake!

Anonymous says:

I prefer owing. We like to have our earned income when it is earned, and we don’t have a problem having and saving money. I don’t understand the penalty thing, and in fact tried to do our taxes online but got confused when estimated taxes and penalties were mentioned. For the first time, we paid H&R Block to do our taxes this year. I’d rather not do that again, but thought it would be the best thing to do since we had to use different forms this time that I’m not familiar with. Our tax bill was just under $2,000, and even though I know we could have kept it and paid at the last minute, I don’t like the feeling of having an unpaid bill. So we filed and paid right away.

Anonymous says:

I’d rather pay through the nose – cause I have the discipline to save the money owed and not spend it. But of course after a certain point the IRS makes you pay quarterly. But I still prefer to owe something. I’d rather have their money until 4/15 than be receiving money in May.

Anonymous says:

I prefer to underpay and owe a small amount. However, I created a spreadsheet that estimates how much I should have had withheld vs what I have had withheld. I update it whenever my situation changes (i.e. raise at work or other unexpected income). This allows me to be proactive and make changes to my withholdings if necessary.

Anonymous says:

Luckily I have this decision made for me. I fill out my W-4 based on facts I know for sure (my salary). But annual bonuses at my firm are completely unpredictable – and usually taxes on bonuses result in over-withholding. I end up getting a little money back each year – not enough to make me sweat about interest-free loans to the government.

Anonymous says:

I like to owe a small ammount but also know what I will owe. I use the IRS’ withholding calculater which can get your estimate pretty close. But each year I also use that based on my previous year’s actual results so I know by what factor I should adjust the IRS’ suggectiosn each year.

This year I ended up owing $404 which is just about where I want to be.

Anonymous says:

For Malaysians, I think the answer is easy. Better to owe the IRS. The M’sian IRS seems pretty tightfisted when it comes to refunds.

I just got my 2004 and 2005 refund.

They have announced that they are getting better etc., but I prefer to err on the side of I owing them.

Anonymous says:

Just remember, when you underpay TOO much (I always did when was W2’d), those penalties definitely offset the standard interest you’d get on that money underpaid in a high yield savings account or CD (Sorry, only going on guaranteed returns for this one). If you just do it one year or there’s a drastic change in income, there are ways of avoiding the penalty though (in case you just want to give it a try).

Just wanted to note that, but in general, I would always prefer to underpay and owe. In fact, in my quarterlies now I even pay at the 90% rate even (though there’s always the hope that I’ll have so many deductions that I’ll still get money back… Hey, I can dream, can’t I?).

Anonymous says:

I have $0 withheld from my paycheck for income taxes. I pull out the tax tables every month and calculate how much should be withheld. I then take that amount out of my budget and put it into high interest savings until tax time. A little extra interest never hurt anyone.

Anonymous says:

I prefer to receive a small refund, but it hasn’t been that way for the last two years as I’ve gotten back nearly $3000 both times. It just shows that I need to tweak my calculations.

If I receive a small refund, the interest-free loan didn’t cost me all that much throughout the year since anything less than $1000 won’t generate significant interest income over the course of one year. And with receiving a refund, I don’t have to worry about my financial state come the following April; I don’t have to worry where the money will come from to pay the government.

I have no need for a “forced savings plan” but the unexpected “income” generated by a surprise refund definitely goes a long way to boost morale and help the household the next year. And, this year, it helped me buy a much-needed washing machine.

Anonymous says:

Three ways to look at it. Owe, Owe nothing, Owed a refund.
You were only looking at Owe nothing and Owing a refund.
If you where able to write a check for the full amount of taxes you owe and you’r end of year tax liability where $20,000, then how much opportunity did you loose?

Anonymous says:

You will get hit by an underpayment penalty from the IRS so you will lose the amount of the penalty. Not to mention, most people aren’t committed enough to set aside $20K and not touch it.