How to minimize your tax liability/refund

Why would you want to minimize your refund? Isn’t that free money? OMG NO

That’s the money you paid over the course of the previous year. If you’re getting a large refund, unless there’s been a drastic change in tax code, it’s probably because you weren’t paying attention to your withholding and allowances.

Let’s imagine a scenario. You, Alfonso, and Babar each buy 12 candy bars from me, costing $1.53 apiece. You, knowing something about how multiplication works, hand me a $20 bill and are not very surprised when I give you $1.64 back. Alfonso gives me $40, and when I give him back his $20 and another $1.64 in change, he thinks (for some reason???) that I’ve given him free money. Babar gives me $15 and is unprepared when he owes more. As you can see, you’re in the best financial situation here. Babar is worse off than Alfonso, but Alfonso is in a position to make financial mistakes like blowing his “extra” $20 on frivolous things because he considers it free.

Similarly, taxes are calculable. They may be complicated, but they are generally predictable, just like how much those candy bars cost. You should know how much tax you are likely to owe AND how much is being withheld from your paycheck.

For most of you, this IRS withholding calculator will do it all for you. It will tell you based on received/projected income and tax-related information how many allowances to take. It even takes into account how much tax has already been withheld based on your previous paychecks – which is super helpful if you hold one or more job(s) for only part of the year. Don’t be afraid if it’s a weird number! I’ve had to put down 10 allowances before because withholding can be weird as a student with different income during the summer and the school year.

Times when you should run the IRS withholding calculator:

  • At the start of a year
  • When you start a new job
  • When your taxable income changes (i.e. if you change your traditional 401k/IRA contributions, or if your side-gig or taxable investments have started making money, etc.)
  • When your tax circumstances change (i.e. if you get married/divorced, have a child, buy a house and can now deduct mortgage interest, etc.)
  • Whenever you’re interested. Seriously, I do this for fun sometimes.

If your tax situation is too complicated for the withholding calculator (or it changed late in the year, with not enough time to change your withholding enough to make up for it), you may be a bit off. Especially for the self-employed, it can be tricky but it’s all the more reason to be aware and prepared so you don’t get caught off guard in April. If it’s the same situation the next year, you can base your withholding/payments on the previous year. If it changes every year, you may not ever be as close as you’d like, but since you are aware of your volatile situation, you’ll be prepared and have a plan in place, right?

Why do we vilify the IRS?

I ran across an older Freakonomics post today that talks some more about one of the consequences of vilifying the IRS – and a less outdated article from the Washington Post showing this problem hasn’t stopped since. The IRS has given tons of outstanding tax liabilities to private collections agencies, who get a hefty cut of around 22%. According to the Freakonomics post, the IRS could collect on this for as little as 3% of the cost if they could hire more employees. But politics and public opinion are such that the IRS cannot get a proper budget to hire actual employees.

As you saw in the John Oliver video last week, we need the IRS to run efficiently. We need service to be low-cost and quick so that this part of having a government is relatively pain free. Privatizing core government functions is nonsensical, expensive, and benefits only the private company. It’s not good for other governmental functions, nor is it good for the citizens who have to deal with it.

So why do we continue to vilify the IRS? They’re not the problem. They’re pretty much never the problem. Who do you think made taxes so complicated, and who do you think is keeping the IRS’s budget low? Congress writes the tax code. Congress writes the budget. WTF, Congress? Do you have any idea what you’re doing to us?