What Is a Tax Refund?

A tax refund is a reimbursement to a taxpayer of any excess amount paid to the federal government or a state government.

Taxpayers tend to look at a refund as a bonus or a stroke of luck, but it really represents an interest-free loan that a taxpayer makes to the government. In most cases, it is avoidable.

Key Takeaways

  • If you get a tax refund, it usually means you overpaid your taxes last year.
  • Regular employees can avoid them by correctly filling out Form W-4 and keeping it up to date.
  • Self-employed people can avoid it by estimating their deductions more accurately.

Understanding the Tax Refund

There are a number of reasons a taxpayer may get a refund of more than a trivial amount of money (or owe more than a trivial amount to the government):

  • The taxpayer has made an error in filling out Internal Revenue Service (IRS) Form W-4, which is used to estimate the correct amount to be withheld for taxes from the employee's paycheck.
  • The taxpayer has forgotten to update this form to reflect a change of circumstances, such as the birth of a child and, therefore, an additional Child Tax Credit Allowance.
  • The taxpayer was eligible for refundable tax credits, which reduces the amount owed. Most tax credits are not refundable.
  • A freelancer or self-employed person who has to file quarterly estimated taxes may over-pay before going through the laborious task of documenting deductible expenses.

The first two examples are easily avoided. That is, the money would have been paid to the taxpayer over the course of the year is the correct information was on the W-4 form.

Of course, sometimes a tax refund is both unavoidable and welcome. For instance, a taxpayer who was laid off early in the year and was unable to get a new job immediately might receive a substantial refund based on his or her actual annual income.

Refundable Tax Credits

Most tax credits are non-refundable. That is, a taxpayer who owes nothing forfeits the tax credit. But there are exceptions.

Refundable tax credits include:

  • The child tax credit. For tax years 2019 and 2020, this credit is a maximum of $2,000, with up to $1,400 refundable.
  • The earned income tax credit. This is a payment to moderate- and low-income workers.
  • The American opportunity tax credit. This is available to taxpayers to offset qualified higher education costs.

How a Tax Refund Works

Tax refunds can be issued in the form of personal checks, U.S. savings bonds, or direct deposits to the taxpayer's bank account, among other options. Most are issued within a few weeks of the date the taxpayer initially files a return.

A tax refund is repayment of an interest-free loan to the government, not a happy windfall. It can usually be avoided.

Refunds are always pleasant, but it would be better to avoid over-paying in the first place by claiming the proper number of allowances on your W-4 form or more precisely calculating your estimated taxes.

Not everyone agrees. Some people consider it an alternative savings plan and look forward to the lump sum repayment.