Your Tax Refund Isn’t What’s Important

Oh, my goodness. You spend 2 minutes communicating with anyone lately, whether in person, on the phone, via owl, or on the internet, and the talk turns to income taxes. Everyone has a story this year, and they want to share it. It’s not surprising; between the changes to withholding last year, and the child tax credit, nearly everyone’s got something going on…

Y’all know me – I love a good tax conversation. Well, I love a good tax conversation when people are talking about actual issues. But the conversations I’m hearing aren’t about the individual parts of the bill, or even the net effect of the changes. People are talking about the amount of their refund or the amount of the remaining taxes that they still owe for 2021.

But you know what? The amount of your remaining tax balance, or your refund, isn’t what’s important here.
I know, I know – it feels important. Getting a big refund from your income tax return can feel like winning the lottery (or so I’m guessing), and having a surprise big tax bill is no fun at all. But the refund or the bill has little relationship to the truly important thing: how much taxes are you paying, in total, figuring your withholding and then adding if you owe more, or subtracting if you are getting a refund.

How Much Are You Paying?

Your total taxes paid (and its relationship to your income) is the only thing that actually matters. When you pay will impact your cash flow, but it doesn’t impact how much you pay.

Your refund is only an indication that you had too much withheld throughout the year, and a tax bill is only an indication that you didn’t have enough withheld throughout the year. You could owe a million dollars in taxes and get a refund if you withheld more than a million dollars. You could have a $500 total tax liability over the year and owe $500 if you didn’t have anything withheld all year.

I’m hearing a lot of people complain that they owe taxes for the first time this year. While owing isn’t ideal, it’s not a terrible thing because it means that you haven’t had too much taken out over the year. The federal withholding tables were adjusted at the beginning of 2021, and folks should have seen slightly less withholding (and correspondingly larger take-home pay) throughout the year.

Understanding How Taxes Work

This brings me to another subject: I am seeing way, way too many people who don’t even have a basic understanding of how taxes work. I realize that it is easy to get removed from your taxes, especially if you’ve always used tax software or used a tax preparer. But it is vital that you understand your taxes, how they work, what impacts your total tax liability, etc. Your software or tax preparer should be your helper, not the sole source of all information tax-related.

First, software and tax preparers are not perfect. If you don’t understand, you won’t recognize mistakes if they make them. (And they do make them.) Second, there are a billion little things you can adjust to make a big difference in your taxes. Unless your preparer is a full-time, experienced tax professional who knows your big financial picture, they’re likely not going to notice how these little details line up so that you can make smart decisions to reduce your overall tax liability.

I’m not saying that you need to go out and get a master’s degree in Taxation. But you need to have a solid grasp of the basic concepts that apply to your tax return. This includes withholding, standard vs. itemized deductions, refundable and non-refundable credits, and tax brackets. If your tax returns are a little more complicated, you may also need to understand other things, including income limits on various credits, depreciation, capital gains, and rental property.

So let’s stop talking about refunds and bills, and focus on the actual yearly tax liability. You’ll be doing everyone a favor – especially yourself!