Tax Refund Definition

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Tax Refund Definition

What Is a Tax Refund?

A tax refund is a payment made to a taxpayer for any excess amount paid to the federal or state governments. While most taxpayers see a refund as a windfall or a stroke of luck, it often reflects what amounts to an interest-free loan paid to the government by the taxpayer. It is often feasible to avoid overpaying your taxes, allowing you to retain more money in your pocket with each paycheck—and prevent a refund when you submit your tax return.

Key Takeaways

  • If you get a tax refund, you most certainly overpaid your taxes the previous tax year.
  • If you qualify for a refundable tax credit, such as the Earned Income Tax Credit (EITC), premium tax credit (PTC), or Child Tax Credit, you may also get a refund (CTC).
  • Employees may avoid overpaying by correctly filling out their W-4s and keeping the information up to date.
  • Self-employed people may avoid overpaying by more accurately anticipating their quarterly taxes.

Understanding Tax Refunds

It might be thrilling to get a substantial tax return. Still, taxpayers are better off not overpaying their taxes in the first place since that money may be better spent elsewhere. You might, for example, change your withholding (or anticipated quarterly taxes if you’re self-employed) and put the “extra” money in an IRA, 401(k), or even an interest-paying savings account. That way, the money works for you rather than the federal government.

To prevent overpaying, fill out your W-4 accurately and amend it if your life changes significantly, such as marriage, divorce, adoption, a new freelancing work or gig, or the birth of a kid.

Here are some reasons why a taxpayer might get a refund:

  • The taxpayer made a mistake while completing Internal Revenue Service (IRS) Form W-4, which is used to estimate the right amount of withholding from an employee’s paycheck.
  • The taxpayer fills up their W-4 on purpose in order to get a greater withholding and a bigger tax refund at tax time.
  • The taxpayer failed to amend their W-4 to reflect a change in circumstances, such as the birth of a kid, resulting in an extra Child Tax Credit.
  • A self-employed or freelancer who files quarterly estimated taxes may overpay in order to avoid a surprise tax bill or underpayment penalties at tax time.
  • The taxpayer is entitled for refundable tax credits, which may lower the amount of taxes payable to zero, even if no tax is owed otherwise. If the credit exceeds your tax bill, you will be refunded the difference.
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Refundable Tax Credits

Most tax credits are nonrefundable, which means they can only decrease a taxpayer’s burden to zero. The taxpayer immediately forfeits any residual money from a nonrefundable tax credit. As a result, this sort of tax benefit is commonly referred to as a “wastable” tax credit.

A refundable tax credit, on the other hand, pays out in full, which means that a taxpayer is entitled to the full amount of the credit regardless of income or tax due. If the tax credit decreases the person’s tax burden to less than $0, the taxpayer receives a refund. Tax credits that are refundable include:

Child Tax Credit (CTC)

For tax year 2020, the Child Tax Credit (CTC) was worth up to $2,000, with a refundable portion of up to $1,400. As part of the American Rescue Plan, the CTC rises to $3,000 for children aged 6 to 17 and $3,600 for children under the age of 6. The credit is now entirely refundable rather than partly refundable, and it has no income cap.

Earned Income Tax Credit (EITC)

The Earned Income Tax Credit (EITC) provides a tax benefit to low- and middle-income employees and families. For 2021, the credit goes from $1,502 to $6,728 and from $560 to $6,935 for 2022. The amount of credit a taxpayer gets is determined on their income, filing status, and number of children.

American opportunity tax credit (AOTC)

The American Opportunity Tax Credit (AOTC) is a partly refundable tax credit that may be used to offset eligible higher education costs (QHEEs).If a person lowers their tax burden to zero before claiming the whole $2,500 tax deduction, the balance may be claimed as a refundable credit up to the lesser of 40% of the remaining credit or $1,000.

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Premium tax credit (PTC)

Low- and moderate-income families may be eligible for the PTC, which reduces monthly rates for health plans provided via federal and state health benefit exchanges. Taxpayers may utilize all, part, or none of their PTC ahead of time (i.e., up front).If taxpayers utilize less PTC than they qualify for, the difference will be refunded to them at tax time.

How a Tax Refund Works

Tax refunds are often delivered in the form of paper cheques sent to the taxpayer or direct payments into the taxpayer’s bank account. Taxpayers may also use their return to purchase U.S. Series I Savings Bonds. E-filing your tax return and selecting direct deposit is the quickest method to obtain your refund.

The majority of refunds are provided within a few weeks of the taxpayer filing their tax return. However, in rare cases, a refund may take longer to process.

Taxpayers who claim the EITC, for example, will not get their returns until March (the law requires the IRS to hold on to these refunds until March due to years of fraudulent filings for the credit).

Refunds are always welcome, but it is preferable to avoid overpaying in the first place by accurately filling out your W-4 or calculating your anticipated taxes. The closer you go to zero, the more money you’ll have for the rest of the year.

Of course, not everyone is in agreement. Some individuals see tax refunds as an alternative savings strategy and anticipate the lump-sum reimbursement.

When can I expect my tax refund?

According to the Internal Revenue Service (IRS), “most refunds are issued in fewer than 21 calendar days.” However, it also adds that, as a result of COVID-19, sent returns take longer to complete than normal, and refunds for certain mailed and e-filed tax returns that need review take more than 21 days. If you claim the Earned Income Tax Credit (EITC) or the extra Child Tax Credit (CTC), your refund will arrive in early March at the latest.

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Why do people get tax refunds?

If you overpaid your taxes the previous year, you will be reimbursed. This might occur if your company deducts an excessive amount from your paychecks (based on the information you provided on your W-4).If you are self-employed and overpaid your anticipated quarterly taxes, you may be eligible for a refund. Tax credits that are refundable, such as the EITC, may also result in refunds.

How do I check on the status of my tax refund?

You may check the status of your most recently filed tax return during the last two tax years using the IRS’s Where’s My Refund? feature. You may begin by checking Where Is My Refund? The IRS will notify you 24 hours after receiving your electronically filed tax return or four weeks after you send your paper tax return.

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