What Is A Tax Refund?

Natalie Thomas  | 

A tax refund is a refund received by a taxpayer if they paid more than they owed to the government that year. This term is often confused with a “tax return,” which refers to the document prepared by the taxpayer to give a full accounting of their income and tax liability. A tax refund is often reported as part of a tax return, but they are not interchangeable terms.

Does Everyone Get a Tax Refund?

The simple answer is no, not everyone receives a refund. Whether or not someone is eligible for a refund on their taxes depends on many factors. To start with, not everyone has to file a tax return. Filing status, age, and income jointly determine whether or not a taxpayer is required to submit one.

However, a taxpayer may not always be entitled to a refund even if they are required to file. While it is possible to have paid more than one owes to the government, the opposite can also be true. If, for example, a taxpayer chooses to withhold too little of their income, they could end up owing the government in taxes due (rather than the government owing them a refund) at the end of the year.

What Does a Tax Refund Mean?

A tax refund is basically just an interest-free loan that the government is returning. For the taxpayer, it is just a matter of deciding whether they want that money immediately in increments or later in a lump sum.

However, as mentioned, choosing to receive the money immediately means running the risk of ending up indebted to the government for that year. For a taxpayer choosing to withhold less from their income, it is important not to misjudge their finances.

Any employee at any legal place of business must fill out a W-4 form, which requires them to declare their withholdings. If the employee opts to have less withheld, they will get more money each pay period, but less in their refund at the end of the year. To some, a tax refund may feel like a nice gift at the end of the year. But in reality, the money always belonged to them.

How to Maximize a Tax Refund

Beyond good old-fashioned financial responsibility, there are many other ways to avoid debt and maximize tax refunds.

One common way of maximizing a tax refund is through tax credits and tax deductions. These may seem very similar, but the key difference is that tax credits directly cut down on the total amount someone owes, while a tax deduction is applied to expenses so that they do not figure into the gross income for that year — which may redefine/lower a person’s tax bracket status.

For example, the Idaho Grocery Credit is a tax credit. If an Idaho resident qualifies for it, the amount the taxpayer owes is lowered by about $100 — which could translate into $100 added to their refund. Meanwhile, a tax deduction can be applied to something like a charitable donation. If hypothetically, a taxpayer’s gross income for the year was $52,000, but they deducted a $2,000 charitable donation from their income, which could drop them into a lower tax bracket.

What to Do With a Tax Refund

Struggling through a tax return can be exhausting. Many people are perhaps justified in rewarding themselves with a new gaming console or an online shopping spree. It is certainly their right to do so — it’s their money, after all. Nevertheless, others may want to take advantage of their tax refunds to get ahead of the personal-finance game, and there are ample opportunities for them to do so.

Pay Off Debt

Some taxpayers find huge relief in using their tax refunds to take a chunk out of personal debt. Debt, in some form or another, is nearly impossible to avoid. This includes credit card debt, medical debt, mortgage payments, etc. Student loan debt alone has risen to $1.5 trillion in the U.S. as of 2019. Even if the refund cannot completely pay off a person’s debt, it can be a huge leg-up in what can feel like a Sisyphean struggle.

Build an Emergency Fund

In the face of the unexpected, even the most responsible budgeter can find themselves in a financial predicament. One cannot completely budget for the random events that manifest in life. Cars break down, pets get sick, employers layoff workers. For such situations, it is helpful to have an emergency fund, and a tax refund is a great way to start or bolster one.

Contribute to Your Retirement Account

A cost one can anticipate is retirement. It is easy to push retirement savings aside in favor of more immediate concerns, but it is better to start saving sooner rather than later. Even for someone who already regularly contributes to a retirement plan, extra retirement funding is an excellent investment. This is a great use for at least part of a tax refund for anyone.

Invest in Yourself

Another way a tax refund can be beneficial to anyone is by helping them to invest in themselves as a person. They could take a college course, whether to improve their career, or just to enrich themselves for personal reasons. They could purchase a bike or a car to make their commute easier. They could even spend it on a vacation in order to wind down and relax after a difficult year of work. This may seem like the least responsible option of those listed here, but that could not be farther from the truth. American culture tends to idealize work ethic and demonize rest and personal enrichment — but that is untenable and actually contradictory to the goal of a productive work life. It is important to budget for life responsibly, but the point is moot if we forget the “life” part.


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This post was updated November 11, 2019. It was originally published November 11, 2019.