Tax Refund Explained by a CPA! - YouTube

So you've been anxiously waiting for your refund  check. And so maybe you're checking your account  

every day, or you're checking your mail waiting  for that check from the IRS, or that payment from  

the IRS. Because you know, you're about to get  thousands of dollars. And yeah sure, it could be  

really exciting but I'm going to tell you in this  video why it might not be such a great thing to  

get a big refund. And this applies to most people,  not all people, and I'll explain that as well.

In this video I'm going to  talk about how a refund works.  

Why it might not be a good idea to have  a big tax refund. I'm going to bust some  

thoughts or myths regarding refunds and what  people think and, and how they think, and  

why it's kind of flawed logic. And also I'm  going to talk about refundable credits, which is  

something that is important to discern between  whether or not a refund is actually good or bad.  

As I said before, a tax refund is not all bad  okay. There are some situations where people  

will get a large tax refund, when their tax  liability wasn't that great. So I'll go over  

that a little later in this video. And also I'll  go over how you can fix your refund situation  

if you've been consistently getting large refunds  in the past or if you've been owing a lot of taxes  

in the past, I'll show you how to handle that  alright. But first let's talk about how a  

refund works. And in order to do that, let's jump  over to the computer so I can show you on there.  

So here you see an example with a payroll, and a  salary amount, and taxes withheld. So as you know,  

if you work at a W-2 job, you have your federal  and state taxes withheld from your paycheck  

every every time you get paid. And what happens  there is that your employer takes your taxes  

from your paycheck and pays the government for  you. So that's what's happening there okay. So  

we're going to just talk about federal taxes.  State taxes work essentially the same way.  

But for this example I'm just going to make  everything very simple, we're not going to  

use actual tax rates or anything. I'm just going  to use a straight 20% just to make things simple.  

So as you can see here, this person  has an annual salary of $100,000.  

And let's say he had $20,000 of taxes withheld  from that and paid to the IRS, from his employer.  

So what happens when he files his tax return  

at the beginning of the following year? Let's see.  So he's going to report his salary of $100,000.  

He's going to take a standard deduction of  $24,000. So let's say this person is married and  

his wife doesn't work okay. So they're married  with one income, that's why they get a standard  

deduction of $24,000. So that brings his total  income to $76,000 you know instead of $100,000.  

Now you can already see 20% of $76,000  is going to be much less than $100,000.

So according to the tax return, this person owes  $15,200 in taxes but the his employer withheld  

$20,000. So what happens to the extra money? It  gets refunded to the person of $4,800 okay. So  

one thing to keep in mind here is that refunds  are not "free money". They are your money that  

you gave to the government and the government  gave back to you alright. Okay so now that you  

know how a refund works, let's talk about  some of the justifications that people use  

to basically justify why it's a good idea to  get a large refund. So the first one I hear a  

lot is that it's it's kind of like a "bonus",  like you're getting a bonus for yourself  

at the beginning of the following year. And you  know, that's not entirely true because this is  

again, your money that you gave to somebody  and then they just gave it back to you.  

So no, that's not like a bonus. Another  justification here is that it ensures that  

"I save" money. If I got that money back every  month or if I got that extra money every month,  

I probably would spend it anyway. So this  ensures that I save the money okay. Well  

let me ask you this, once you get the money back  as a refund what the hell do you do with the money  

okay? Do you spend it on something crazy,  or do you put it in a savings account,  

or what do you do with the money? I understand  that sometimes people need more extreme measures  

to help them save money. You know, like kind of  out of sight out of mind thing. But there are  

much better ways to do that because if you're  if you're using the IRS to help you save money,  

you're not making any money on that savings.  So one thing you can do is have your employer  

direct deposit the excess money into a separate  savings account okay. Because if you have direct  

deposit, you can actually have that money, your  income, your pay deposited into multiple accounts.  

So that's one option. Another option is just  to have it all direct deposited into your main  

checking account and have automatic transfers  out to a brokerage account, or savings account,  

or whatever it is automatically, every month.  So you don't even have to think about it. Those  

are some much better options because you would  actually make some money. Even a savings account,  

you know like some banks, like Ally  Bank, you at least make some money  

rather than making zero money, giving it to the  IRS. And the last thing I hear people say a lot  

is that they like to buy themselves a nice treat  with their with their tax refund money. You know,  

they'll go buy something new and fancy,  or some toy that they wanted for a while.  

And you know, you've just got to ask yourself  is that really the best use of your money.  

You know, and it's not it's not my place  to say that that's a waste of money  

because people have different values from  each other and some people might really value  

enjoyment or joy from from these things that  they buy. So it's just a scenario to ask,  

is that really worth your money? And again  if it is, it's still better to put it in your  

own savings account or your own brokerage account  and have it earn money while you save up for that  

thing that you're looking for. Okay so now that we  talked about some justifications that people have  

I'm going to talk about one scenario where a  big refund is a good thing for these people okay.  

So let's jump back onto the computer. Alright so  I'm going to talk about what's called a refundable  

credit. A refundable credit is a credit that you  get back as a refund even if it's greater than  

your tax liability. And this usually applies for  more lower income people or lower to middle income  

people with a lot of kids or with children  okay. So here in this very simple example,  

we have somebody making a $15,000 salary okay. And  let's say their their tax liability is $1,500 or  

10%. Now let's say they have one child and they  qualify for this earned income credit okay. Now  

as you can see the earned income credit is  $3,500. Their tax liability is only $1,500.  

So because the earned income  credit is a refundable credit,  

this person will still set a refund of $2,000,  even though their tax liability was only $1,500.  

So that is what a refundable credit is. And if  you're in this situation you know, where you  

you have a child tax credit, and you have  an earned income credit, or the American  

opportunity credit, those are three of the main  refundable credits, then you don't have to feel  

like you need to adjust anything on your W-2 or  on your W-4. You know it's not that big of a deal  

as those people who are making more money  and receiving a huge, huge refund okay. So  

this is basically a refundable credit in a  nutshell. So most tax credits are non-refundable.  

Which means that it will take your tax liability  down to zero but then it won't give you a refund  

okay. It will carry any excess credit left  over to the following year. So what do I mean  

by that? So let's change this to a non-refundable  credit. So now you have a tax liability of $1,500,  

a non-refundable credit of $3,500. That's going  to give you a refund of $0 because you know,  

the credit is greater than the tax liability  so it eats away the entire tax liability okay.  

That means there is a $2,000 carryover to  the following year. And in the following year  

you know, if your tax liability increases then  the credit that you carried over will you know,  

start to eat up that tax liability for the next  year and so on and so forth. And it will keep  

carrying forward until it's used up. So let's  say you're not in a refundable credit situation,  

and let's say you do have either a huge refund  at the end of the year, or you are owing a lot  

of taxes at the end of the year. So what can you  really do about this? The the main thing you can  

do is to adjust your W-4 with your employer.  Now there used to be a version of the W-4 that  

would just have you put in the number between  0 and 99, there's some calculation that you can  

you can go through to come up with the number.  But it's just like putting in this number that  

kind of determines what your tax withholding  is. And in my opinion, it wasn't that great of  

a system because it's a lot of, it could be off,  you know there could be some guesswork there.  

So there's a new W-4, which I think is much  better, and it uses your actual income numbers,  

and your actual deductions that you expect, and  it calculates your withholdings that way. That's  

the one, one of the main things you can do to  adjust your refund or your taxes due at the end  

of the year is to adjust your W-4 with your  employer. Another thing you can do is use the  

IRS tax withholding estimator tool. That way  you can see mid-year what's going to happen  

at the end of the year when you file your  taxes. It's a good way to kind of predict  

you know, whether or not you're going to get  a large refund, or you're going to owe a lot.  

And that's going to help you determine how much  more withholding or how much less withholding  

you should be taking from your employer as of  the middle of the year okay. Now if you use  

that tool, and you go that route, just be sure  to actually change your withholding back at the  

beginning of the following year to make sure  it's consistent for the entire year alright.  

So that's all I've got for today. Thanks for  joining me. If you're new here, I'd really  

appreciate it if you'd subscribe to my channel and  stay up to date with everything business and tax  

related. And also smash that like button and share  this video with your friends who you may think can  

benefit from it. And leave me a comment below with  any concerns, questions or anything that you might  

have and I'll do my best to get to them. Alright  so take care for now and I'll see you next time.