Tuesday, March 29, 2016

Time to review age-old debate over tax refunds


FROM DENVERPOST.COM
As you are going through tax season, you've probably started on your taxes or maybe even received your refund by now. You may have even "mentally spent" your refund on a vacation or debt pay-down, or targeted it for savings and retirement. With options such as these, why do financial pundits recommend avoiding refunds?
The traditional money-pro thinking is that by getting a large refund, you are giving the Department of Treasury an interest-free loan all year long. And does the Internal Revenue Service allow interest-free loans the other way for those who owe large amounts? Of course not. Penalties for underpayment can be applied if you don't have enough withheld or paid in during the year.
The traditional line of thinking remains that it's better to have those dollars working for you throughout the year instead of for the government.
I used to support getting a refund since from a behavioral economics standpoint, having extra dollars withheld through payroll without being able to access them is a forced way of savings.
With a little bit of discipline during tax season, those dollars can be targeted toward worthwhile financial goals. The key point is to take a disciplined approach toward one's refund, as it can be tempting to spend the dollars frivolously. Combined with today's low interest rate environment, the trade-off seemed worthwhile.
My world view has recently changed on the subject, but it's not due to the same rationale that financial pundits hold. It's due to the ever-growing threat of identity theft as it relates to the tax filings. Many of the same people who get large refunds are reliant upon those checks as they serve as a form of forced savings. Then the unexpected happens: They file their taxes and find out their return is being rejected because a 1040 has already been filed in their name. Now, that rightfully owed refund check has been put on hold.
According to TIGTA, which is the agency that provides independent oversight of the Department of Treasury and the IRS, the average wait for tax account identity theft to resolve — and get taxpayers their refund — is 278 days, or more than nine months! In addition to not getting an anticipated refund, there's a mess to clean up, all while Congress continues to slash the budget of the IRS, making assistance more difficult to receive.
Most likely, one's personal information was stolen through a data breach, phishing attempt or other scam. Thieves use the personal information to file a fake tax return with made-up income numbers to generate a 1040 and claim a fraudulent refund. They may also try to claim someone else's children as dependents. According to the Federal Trade Commission, 32.8 percent of all identity theft complaints in 2014 pertained to taxes or wages, no small amount. In addition, there's a whole black market for Social Security numbers, making identity theft with tax returns an easy target.
Phone scams continue to be a threat to taxpayers as well. The thought of a call from someone pretending to be an IRS agent is a scary proposition. The scammers also take a hard-line stance by demanding immediate payments. Know that the IRS won't call demanding immediate payment without first having mailed a bill, and giving you the opportunity to question or contest the amount. One defense tactic is to ask for the caller's name and tell them you will call right back at 800-829-1040.
Of course, owing at the end of the year won't protect you from tax-related identity theft, but it does mean that you aren't put on hold to get your hard-earned money. Please don't interpret this as a reason to have a big balance due either. As I mentioned before, there are potential penalties for not paying enough in throughout the year. The general rule is that you have to pay 90 percent of the current year's taxes in or 100 percent of the prior year's tax liability in to avoid an underpayment penalty. It goes up to 110 percent of the prior year's liability for those who have an adjusted gross income of $150,000 or more.
As we work to get through the tax season, take a few minutes to analyze your current withholdings. If necessary, use this IRS calculator to make an informed decision about changes:irs.gov/Individuals/IRS-Withholding-Calculator.
A few minutes of tax planning now can help you avoid a headache in the future.