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4 Ways to Reduce Your Tax Refund (And What to Do Instead)

by
Ashraf Khatib
on
2/20/2020
4 Ways to Reduce Your Tax Refund (And What to Do Instead)

Note: The tax filing and payment deadline for 2019 tax returns has been delayed from April 15, 2020 to July 15, 2020.

The IRS only began accepting individual tax returns on Jan. 27, but it's already processed more than 10 million refunds at an average of $1,952 per refund. And if you're like most taxpayers, you're probably expecting a refund, too.

Sure, it may be exciting to get a big tax refund after filing your return. You might already be planning what you want to do with that refund check.

But the reality is your tax refund is just your own money — money that could have been earning interest throughout the year if you'd kept it instead of overpaying the IRS.

Of course, you want to keep your total tax liability as low as possible. But at the same time, reducing your tax refund is often a smarter financial move than increasing it, even if it may seem counterintuitive. Read on to find out how to reduce your tax refund.

1. Review Last Year’s Taxes

Did you receive a big tax refund last year? Assuming your financial situation will be mostly the same this year as it was last year, you can probably expect to receive a similar refund. The goal is to get that tax refund as close to $0 as possible, while still taking advantage of all the tax deductions and credits that you can. If you got a big refund check last year, that’s a good sign that it’s time to make some changes.

You can also use last year's tax return to estimate your tax liability for the upcoming tax year. While it’s beneficial to decrease your tax refund, you also don’t want to owe the IRS too much, which could lead to financial penalties.

Estimating your tax liability is especially important if you have income that isn't subject to withholding; in that case, you'll need to make quarterly tax payments to avoid owing penalties at the end of the year.

2. Update Your Withholdings

If you want to change the size of your tax refund, your withholdings are a good place to start. If you owed too much in taxes last year, you'll need to increase your withholdings. If you got a large refund, that usually means you should decrease your withholdings.

You can use last year’s return, in addition to the IRS’ Tax Withholding Estimator, to estimate and make adjustments. Remember that you can submit a new Form W-4 to your employer at any time.

3. Look Ahead

It’s not always possible to predict events that will change your tax situation, but it's worth trying by looking to the future. Are you expecting a child? Are you planning on getting married? Is your income going to change significantly? All of these situations can affect your tax liability.

If your financial situation is going to be significantly different than last year, basing your actions on last year’s tax return may not be enough.

4. Talk to a Tax Expert

Qualified tax experts can give customized advice based on your unique financial situation. It’s never too late to find one to talk to — and the sooner, the better. Proactive tax planning is far more likely to result in good outcomes than simply talking to your tax preparer only annually during tax season. 

Now, once you've reduced your tax refund, what should you do with your increased monthly earnings?

Save

One reason taxpayers are reluctant to give up their large tax refund is that it forces them to save by eliminating the possibility that they'll spend that money throughout the year. But if you can find the willpower to save on your own, you can put away even more savings when you include interest.

For example, let's say you get a tax refund of $2,400. Spread over a year, that translates to an extra $200 of income per month. Over a year, if you put that money into a high-yield savings account with an interest rate of 1.7 percent that compounds monthly, you could earn around $20 in interest. And hey, $20 may not be much, but it's more money than you'd have if you'd just waited for your tax return.

If you keep up that same strategy, assuming all the same numbers, for 10 years, you'll earn more than $2,000 in interest.

And if you're still concerned you might spend the money if it's available to you throughout the year, try using direct deposit to send your extra earnings directly to a savings account.

Pay Off Debt

Many taxpayers plan to use their refunds to pay off debts. But if you have some extra cash to pay down debt throughout the year instead of in a lump sum, you could save a lot of money in interest.

If paying down your debt doesn’t feel manageable without that big refund check, try working with a company that specializes in debt relief to come up with a sustainable plan.

Invest

If you want your money to earn interest, investing is riskier, but far more lucrative, than relying on the interest from savings.

For example, the average annual return for the S&P 500 Index is about 10 percent historically, according to Investopedia. If reducing your tax refund increases your monthly income by $200 and you invest that money each month, you could earn more than $15,000 in interest, compounded monthly, over 10 years with an average return rate of 10 percent.

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Ashraf Khatib

Ashraf Khatib

Ashraf Khatib is the founder of Tax for Expats, LLC. Prior to establish the expatriate tax business, Ashraf was employed by the Big Four (4) CPA firms as the head of international client services group, where he managed the individual expatriate and foreign national tax programs for an impressive array of their clients which included high net-worth individual clients, multi-national companies and professional firms. Ashraf received his BA in Economics from Southern Illinois University, and an MBA in Finance from Southeastern University, he is an active member of the AICPA and the Virginia Institute of Certified Public Accountants.

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