Tax Refund Pros and Cons: What Are the Downsides of Receiving a Tax Refund?Income Taxes
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Every year, the IRS issues over $400 billion in tax refunds.
That’s a lot of money — money that arguably would have been best left in taxpayers’ pockets to begin with.
While it’s exciting to receive a large tax refund, it’s important to understand that there are definite pros and cons to receiving one.
Before we get into the specifics of the benefits and downsides of receiving a tax refund, though, here’s what you need to know: tax refunds are an industry in and of themselves.
The Tax Refund Industry
Between January and April every year, there’s a pop-up industry that has become a part of our collective American culture.
It’s called the tax refund industry.
This industry tells you that:
- tax refunds are awesome and therefore
- the bigger your refund, the better.
This industry has two major players: tax preparers and big-box retailers.
Both tax software companies and walk-in tax preparation offices have the same guarantee: “We’ll get you the biggest refund, guaranteed!”
And while their products and services should help you to maximize your legal tax deductions to prepare your tax return correctly, shouldn’t the promise rather pertain to accuracy rather than the size of the refund?
It’s almost an assumption that when you file your taxes you will receive a refund — rather than break even or have a tax due — and tax preparation companies milk this for their marketing.
Check it out: Here’s our review of the popular TurboTax software.
It’s no secret that many retailers work Americans’ proclivity to impulsively spend their tax refunds into their own marketing and sales forecasts.
In 2019, for example, online home goods retailer Wayfair held a 36-hour-sale beginning on April 10.
Clearly, the company was expecting that people would have money in their pockets thanks to their tax refunds.
In fact, oftentimes the tax preparers and the retailers work hand-in-hand to main the “refund culture” this time of year.
For example, Jackson Hewitt — the walk-in tax preparation company that maintains over 3,000 offices within Walmart stores — is offering its customers a 5% bonus for putting their tax refund on a Walmart gift card.
Just imagine that: someone walks into the Jackson Hewitt office in a Walmart and then walks out with their $1,000 refund on a Walmart gift card, ready to spend right away!
Tax Refund Pros
1. A tax refund is a forced savings account.
If you’re not the best with maximizing your savings, a tax refund could be a good way for you to force yourself to save throughout the year.
The trick, of course, is to actually save your refund check rather than spending it.
2. Getting a tax refund minimizes penalties.
The IRS likes to be paid on time and on a quarterly basis.
And if a taxpayer doesn’t pay their taxes on the IRS’ schedule, the IRS will assess penalties for underpayment of taxes.
But if you get more taxes taken out of your paycheck every pay period than is necessary — which is what causes a tax refund in the first place — then you can rest assured that you won’t have this problem with the IRS.
Tax Refund Cons
1. You’re giving the government an interest-free loan.
If I asked you to loan me a few thousand dollars, interest-free, for the next six to twelve months, you’d say I was crazy.
But if you get a large tax refund, this is exactly what you are doing for Uncle Sam throughout the year.
A tax refund isn’t free money from the government; it’s your money that you let the government do with as it pleases until you file your tax refund and receive your refund check or deposit.
2. You don’t have the money to use throughout the year.
Since the government has your money, and you don’t, you don’t have the option of using it throughout the year to reach your other financial goals.
Here are some things that you could be doing with your would-be tax refund money if you had it at your disposal throughout the year:
- Paying down debt to avoid interest
- Investing in the stock market and earning a return
- Depositing it in a savings account to earn interest
3. A tax refund is a temptation.
For many people, a tax refund feels like a windfall — an unexpected stroke of good fortune.
And as with most windfalls, the temptation to spend your tax refund is strong.
Or maybe you aren’t tempted to spend all of it, but it certainly doesn’t feel like much to blow $300 of your $3,000 refund, right?
The magnitude of a tax refund can trick you to make poor decisions with at least a portion of it.
Frequently Asked Questions
- What is a tax refund?
A tax refund is an amount of money that a taxing authority sends you after you file your income tax return because the amount of tax credited to your account for the tax year exceeds the amount of tax (including any penalties and interest) that you actually owe for the tax year.
- What is the maximum tax refund you can get?
There is no statutorily-set maximum tax refund. If you theoretically paid in a billion dollars to the IRS for this tax year but didn't actually have a tax liability for the year, you would receive a billion-dollar tax refund.
- What is the average tax refund?
The average tax refund is approximately $2,900.
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Logan is a practicing CPA, Certified Student Loan Professional, and founder of Money Done Right, which he launched in July 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.