Tax Tantrum Tuesdays: What is the point?

Tax convos between myself and close friends are revving up as tax season is well underway. One thing I've noticed...time and time again, is that people don't really understand the purpose of the infamous tax return. More specifically they don't know that doing it "right" means owing $0 and getting $0...it means paying in exactly what you owe.

Nowadays I get annoyed when I hear folks say..."Girlllll, I can't wait for my refund!" The point of the tax return is NOT to have a refund. Of course that is more desirable than having to owe but the most desired outcome is to owe nothing and receive nothing. You think I'm crazy...hear me out.

So when you start a job, you fill out a W-4. It asks you to specify how many allowances you want to claim for your federal and state withholding. For most single folks with no dependents we put 0 or 1. Sidenote: you can actually put whatever number you want. hahaha. For some reason I remember someone telling me I had to put 0 or 1. Now I know that's not true. I can't put 5 if I damn well please...but that would be very dumb. 

Anyway, what exactly does this number mean and what does it control? That number tells the government how much money to take out of your check every pay period for taxes. By law, everyone has to pre pay at least 90% of their taxes throughout the year (or an amount equal to 100% of your previous years taxes). Sorry, that was technical. In short, that just means, if you wanted to just have no money withheld from your check and write the government a big fat check in April for whatever tax you owe, you could be assessed a tax penalty because by law you have to pay 90% of that tax throughout the year. So this rule is why we even have federal taxes withheld from our checks in the first place.

Now, for the fun part. The lower your federal allowance (remember the 0 or 1) the MORE money the government takes out of your check. This means if you're 25 with no deductions and you practically get taxed on all of your income then you should probably be at 0 or 1. But if you're a 25 year old who owns a home and contributes tons to charity (thereby racking up let's say $20,000 in itemized deductions), you know that your taxes are going to be lower...so you might hike that allowance number up to 2 or 3. That's what you're supposed to do. Now let's talk about what happens when you ignore these facts and decide you're gonna cash out every April.

See you think you're smart...but the fact of the matter is the government is smarter (and then there's me of course...the smartest teeheehee). The government has you GEEKED UP because you get this huge check in April...but what you don't know is that, THAT check is of total benefit to them and not a lot of benefit to you. I know this is getting good right.

 Let's say you're the 25 year old with a house and you contribute tons to charity. You have itemized deductions of about $20,000 but you leave your allowance number at 0 because you want to have a fat return. Let's say tax time roles around and your accountant tells you that you're getting a $7,000 refund on the money you overpaid in taxes...you're elated...money money money monayyy. Wait a min...SAY WHATTTT? I overpaid the government? You mean to tell me, there was $7,000 I could have been getting in my paycheck over the course of the last year (if you get 24 paychecks a year that's an extra an extra $291 PER paycheck you've been missing out on) but I basically let the government hold a 0% interest loan (from my broke a$$).

Does that make you feel dumb? It's okay, I still struggle with being excited about the little refund I get. The government is basically getting a free loan up outta ya. Holding on to your overpayment for 12 months (well actually 15 months if you count Jan-Mar of the next year) and not even paying you interest!

Now some of you ambivalent folks who don't want to believe that your tax refund in fact is not the best thing since sliced bread may say...so what?! I mean regardless of whether I'm getting it in my paycheck (extra $291 each paycheck) or all at one time ($7,000 tax return)...at least I'm getting my money.

Well for youuuu...let me tell you like this. TVM. Time value of money. #1 rule of finance...a $ today is worth more than a $ tomorrow. Actually the only thing I really remember from finance...lol. If you took that $291 each paycheck...deposited it into an investment providing an 8% return (for the sake of simplicity let's just do simple interest) you would end up with $7,560 at the end of 12 months. You are more than halfway on your way to some red bottoms with an extra $560! So now, think about it like that.

This has gotten long so...

Let's recap: What is a tax return? A loan you've given the government...that they hold on to...interest free...for 15 months...and then give it back to you like they're doing you a favor.

Now, trick question, what should a tax return be?

$0 and [almost] a pair of red bottoms. Woot woot! #pow

Til next Tuesday....