Refund or Pay: Where are the advantages?
WARNING I am about to do Math. Some may want to look away.
If you look to the tax code you will find the federal government will allow you to owe up to $500 without penalties or interest and most states will allow you $100 or more. At first glance we can see this as an interest free loan. That’s $600 you could use or simply keep in savings; at 3% you could earn an additional $18. Honestly, since you would only be collecting it a little at a time in your payroll, you would earn a little less. Yet, you do get to use it for an extra 3.5 months. (Let’s call it $12.)
Another plus is the payment of past taxes is a direct write off. It is a line item deduction when you pay past taxes. So paying last year’s tax, the above mentioned $600, would come right off the top of your gross income line. That could net you a savings of $60 on this year’s tax. (12 + 60 = $72 in savings)
Let’s look at the refund side. The average refund is around a thousand dollars. That means you don’t have access to your money and the government does. This is your money. If we were to account for simple interest of 3%, you would have lost about $30. If that wasn’t enough of a burden, some states (like Oregon) treat refunds as additional earnings in the year they are received and demand further tax on the money. In Oregon that would be about $80. (30 + 80=$110 in loss)
Those of you taking the refund have another burden to bear. In simple economic terms, Money Today is Worth more than Money Tomorrow. Why is that you ask? Simple inflation steals a little of each dollar each year. We may only have a 1% inflation rate but that $1000 refund lost about $10 in market value. If you are lucky enough to not live in a state like Oregon then you only have suffered a loss of $40. (Oregon resident $120 loss)
The tax payer has got to fully use their money for the whole year, plus took advantage of a free government loan and came out about $72 ahead. They might look a little depressed having to a cut that check to Uncle Sam but they are the real winner.
The person who received the refund may be thrilled to receive that fat check but after careful review, that smile will flip over knowing they just lost $112. (40 + 72 = $112) This may look like small potatoes in the grand scheme of things but over a fifty year work cycle this could develop into a nice nest egg of $5600. If we were to place this in an IRA at 6% the net balance would be $34,469.
I think you might be able to find a use for this small contribution. If not I could give you an account number to place it in. I can think of all sorts of ideas.