January marks the beginning of tax season, with W-2, 1099 and 1098 forms being sent out or printed at home by millions. Many Americans see tax refunds as extra cash once a year to be used for vacations or new toys or maybe to be put in savings.
However, certified public accountants such as Paul P. Scholz, managing partner at Onisko & Scholz LLP, point out that this is not the case. Monies given as tax refunds were free loans to the federal and state governments that earned interest which taxpayers will never see – essentially, free money for the government.
Paul P. Scholz, managing partner at Onisko & Scholz LLP, said he advises clients to adjust their tax withholdings to the point where their tax returns are minimal. (Photograph by the Business Journal’s Larry Duncan)
“We don’t like to see people get huge refunds, simply because of all the forgone opportunities there,” Scholz said. “So the better solution is to plan for no tax refund and just break even.”
The basic idea is to adjust withholdings to the point where no money is owed to the government and tax refunds are minimal or nonexistent. It is like a game on “The Price Is Right,” and you want to get as close to zero as possible without going over.
Scholz recommends doing this and then using the extra money for savings, IRAs, 401(k)s or any other system of money management that will earn interest for the individual, rather than the government. This strategy allows taxpayers to not only put more money in their pockets but also keep from being dependent on tax refunds, especially considering past scares of California withholding refunds.
Despite these recommendations, many CPAs acknowledge that tax withholdings are the easiest and most sure way for taxpayers to save money. Because of this, many CPAs suggest a hierarchy of uses for tax refunds.
Unlike Scholz, who said savings and retirement should be the first priority, Blake Christian, a partner at Holthouse Carlin & Van Trigt, said he advocates for paying off high-interest debt, such as credit cards and student loans, first. After this, Christian advises saving for the future.
“Things like car loans and mortgages, the interest rate is usually pretty low on those, unless somebody has bad credit,” Christian said. “So my advice these days is to kind of keep that debt outstanding because it’s pretty cheap money and maybe utilize the cash for something else. If you don’t have a whole lot of debt, then start looking at investment alternatives or retirement funding.”
Rick Pielago, president of Vuoso, Pielago, Spranza & Associates Inc., pointed out that everyone’s tax situation is different, requiring various strategies for filing and options once refunds are received. Aside from retirement funds, Pielago recommends many clients roll their refunds over to the following year’s taxes, ensuring no penalties and eliminating any risk of not using the money wisely.
“A lot of our clients are self-employed. So they really don’t end up getting refunds, because if they’re overpaid, they end up applying it as credit to the subsequent year’s tax,” Pielago said. “That happens with quite a few of our clients.”
Scholz said this tax rollover is what happens with many of his clients as well. He explained that it is a painless way to ensure proper tax management and security.
Christian said a major problem in preparing taxes is that people do not keep good records. He explained that official forms such as W-2s and 1099s are simple and straightforward, but ferreting out tax-deductible items is much more difficult. He encourages people to always ask their tax preparers a lot of questions to maximize returns. Scholz encourages people to have a plan for when their refunds come in.
“If [people] don’t have it specifically earmarked to invest or pay debts or something like that, then all of a sudden it becomes a windfall, and they’re likely just to blow it,” Scholz said.
This sentiment pairs nicely with Christian’s last bit of advice: “Don’t go to Vegas.”