As tax season comes to a close, many people are looking forward to receiving their tax returns. After all, it’s a time when the government gives back the money you’ve overpaid in taxes over the year. While some people may see their tax returns as a bonus, it’s important to remember that it’s your own money that you’ve overpaid in taxes, and you should use it wisely.
In this Money Chat, we will help you understand how tax returns are calculated, and how you can get the most value out of utilizing your returns.
How a Tax Return is Created
The first step to understanding this process is to understand how a tax return is created. When you file your taxes each year, you report your income and expenses to the government. Based on that information, the government calculates how much you owe in taxes. If you’ve paid more than you owe over the course of the year (either through withholdings from your paycheck or estimated tax payments), you’ll get a tax refund. This refund is essentially the government returning your overpayment of taxes.
For most Americans, and many across the globe, tax season isn’t one with a return, however. As you earn paychecks, your company files your income in whatever state you reside in legally. If you are paid while living in Massachusetts, for example, your paycheck will have a certain amount of money withheld each pay period for things like Medicare, Social Security, Federal Taxes, and then State Taxes. Each state has their own set of tax codes and regulations, and some states do not collect income taxes at all (i.e., Texas, Florida, and South Dakota amongst others).
After your taxes are collected each paycheck, and your federal and state taxes are filed each year before mid-April, the amount of money withheld is checked against your annual tax credits, your total income (including any additional income from investments, side gigs, etc), and your total owed taxes. For some, a return is issued as the government withheld more of your paycheck than required. For others, you end up owing more toward state and federal taxes based on additional income sources.
How to Use Your Tax Return Wisely
One unique way to utilize your tax return is to borrow against the check coming in the mail. Instead of waiting for your tax return to come in the mail, you can get your money sooner by borrowing against it. H&R Block and other tax prep companies offer this service, allowing you to get a loan based on the amount of your expected tax return. This can be especially helpful if you have debts that you need to pay off or if you have other expenses that you need to cover.
By using your tax return to pay down debts, you can also improve your credit score and secure cheaper credit in the future. When you have high levels of debt, it can be difficult to get approved for loans or credit cards with favorable interest rates. However, by paying down your debts, you can lower your credit utilization ratio (which is the amount of debt you have compared to your available credit), which can improve your credit score. With a higher credit score, you may be able to qualify for better interest rates and terms on loans and credit cards.
It’s important to note that borrowing against your tax return is not free. H&R Block and other tax prep companies may charge fees or interest on these loans, so it’s important to read the fine print and understand the costs associated with borrowing against your tax return. Additionally, if you don’t receive the full amount of your expected tax return (due to errors or audits), you’ll still be responsible for repaying the loan.
Additional Cash Options for your Tax Return
For those with no outstanding debts, your tax return may be the perfect scenario to invest, save, or explore life improvement options all without having to dip into your checking account.
- Save for emergencies: It’s always a good idea to have some money set aside for emergencies. If you don’t already have an emergency fund, consider using your tax return to start one. This can help you avoid going into debt in the event of an unexpected expense, such as a car repair or medical bill.
- Invest in your future: Your tax return can also be a great opportunity to invest. Consider opening a retirement account or contributing to an existing one. You can also use the money to pay for education or job training that can help you advance your career. If you feel secure and have a trusted financial advisor, tax returns also can be reinvested into secure stock market accounts or long-term portfolios.
- Make home improvements: If you own a home, using your tax return to make improvements can increase the value of your property and, depending on the project, may save you money on energy bills. Consider making upgrades such as installing energy-efficient windows or exploring solar panel options for your home.
- Treat yourself (but within reason): While it’s important to be responsible with your tax return, it’s also okay to treat yourself a little bit. Consider using a portion of the money to do something fun or indulge in a small luxury. Just make sure you’re not overspending or jeopardizing your financial goals.
By paying off debts, saving for emergencies, investing in your future, making home improvements, and treating yourself (within reason), you can get the most value out of your tax return and improve your financial situation.
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The information contained in this article is meant to serve as general guidance for consumers and not meant to serve as comprehensive financial advice. For questions about your individual circumstance, finances, or accounts, please contact your creditor(s) and/or financial advisor directly.
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Alliant Capital Management is a professional debt collection company that provides recovery services for creditors. We have decades of experience in delivering compliant and affordable debt collection services. As members of both Receivables Management Association International and ACA International, we are committed to providing the best possible experience for consumers. Alliant is headquartered in Buffalo, NY with an additional office in Chandler, AZ.