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Everything you need to know about tax refunds

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If you're getting a tax refund, you're potentially giving up an even better opportunity: more money in your pocket year-round.

During the early part of the year when Americans are filing their tax returns, millions end up getting a refund check from the government. Last year, the average tax refund was more than $2,800 — money that many people used to splurge on a vacation or other big purchases.

While a tax refund can be a welcome boost for your checking account every year, the fact that you're getting a refund at all may be a sign that you should revisit your withholding. Doing so might be able to save you money in the long run.

A lot of people stand to save, too. As many as 30 million people withheld too much in 2018.

Why you get a tax refund

The reason you would receive a refund at all is because you've given the government too much money over the course of the year. How much you get back, or owe, is related to how much you've already paid the federal government in taxes.

"You're getting a tax refund because you overpaid your tax liability for that tax year," says Riley Adams, a Bay Area-based CPA who runs the financial website Young and the Invested. Each paycheck you receive, he says, your employer withholds money for your income taxes and sends it to the federal government.

You're getting a tax refund because you overpaid your tax liability for that tax year.
Riley Adams
CPA

When you fill out your tax return, you're essentially computing your tax liability, which is the total amount of tax you owe to the IRS. If what you paid is more than what you owe, you get a tax refund.

"Some people look at it as a form of forced savings, and each year it's a sort of bonus that they come to count on," Adams says. But for many people, it might be better to not overpay and instead adjust your withholding.

Getting a refund may be a thrill but it can cost you in other ways

"If you underpay your taxes, they'll hit you with a fee. But if you overpay, you don't get a bonus," says Justin Halverson, a financial advisor at Great Waters Financial in Minnesota. Since you're not earning any interest or getting a bonus for loaning out your money, most people may find it more beneficial to put that money to use as they earn it.

"People tend to blow a refund check," Halverson says, "when they could have been systematically saving that money or investing it." If you're in debt, for example, you could have used the additional income over the course of the year to help pay it off and potentially become debt-free sooner.

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How to adjust your withholding

Experts say you should aim not to owe, or be owed, anything — you want to pay as close to the correct amount of tax as possible. In order to accurately estimate your liability, there are a couple of things you can do.

Use an IRS calculator. The IRS has a Withholding Estimator tool that can help you reach a proper estimate. It will tell you your expected annual income and what you should expect to owe the government. But be aware that there are a lot of variables at play, including where you live and how much you earn. And you might have to take into account any additional income you may earn from side hustles or investments, for example.

Once you know what you should be withholding, talk to your employer about making the adjustment on your W-4 form.

Do a mock tax return. Fire up your preferred tax-filing software and start plugging your numbers in. You should get an estimated refund figure, which you can use to gauge whether you can expect to get money back during tax season, or if you're not paying enough.

"Doing a mock tax return to see if you're on track or not" can be an easy way to do a midyear check on your withholdings, says Halverson.

If you feel that you're in over your head, you can always reach out to a pro for help. "Sit down with a CPA or financial professional to make sure you're where you want to be."

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