Small Business Tax Mistakes - Why Getting a Big Refund is a Bad Idea

I will never forget the day that a tax client came into my office to pick up his income tax return.

"How's it look?" he asked.

"Well," I said, "It looks like you're getting a refund."

"Great! How much?"

"Oh, it's a big one," I said. "Over $5,000 dollars."

Mr. Client couldn't have been happier. He face lit up like a light bulb. He was ecstatic -- he sincerely believed that he had "beat the tax man" by getting such a large refund.

I was not so happy. I couldn't understand his thinking. So I asked Mr. Client if he really meant to get such a big refund. I wondered if his payroll department made a mistake -- maybe they were doing his withholdings wrong. Maybe he didn't really want to have so much tax taken out of his paycheck each week.

Mr. Client went on to tell me that he's always had a tremendous fear of having a balance due on his return. For some reason, he just assumed that if he ended up owing money to the government at the end of the year, then somehow he would get in trouble with the IRS. So he went to the opposite extreme.

In addition, Mr. Client thought that getting a big refund was a great way to save money during the year, so that at the end of the year he got a nice little "bonus" from the government. You know, a forced savings plan.

I spent a few minutes with Mr. Client and gave him my opinion on this whole topic of getting a big refund.

My biggest objection to getting a large refund is the simple fact that you have given the IRS an interest-free loan of your hard-ea
ed money. If Mr. Client wanted to save $5,000 dollars over the course of the year, all he had to do was authorize his employer to deposit $100 per week into his savings account. Then at the end of the year, his $5,000 would be sitting in his own bank account rather than sitting at the U.S. Treasury.

That $5,000 could have been earning interest over the course of the year. So by letting the government keep his money, Mr. Client was actually losing money!

I also explained to Mr. Client that getting a large refund does not, in and of itself, put you on some IRS "hit list." Plenty of people do what Mr. Client did (have way too much tax withheld from their paychecks) and the IRS doesn't really care. Hey, they got to keep your money for awhile, so it doesn't really matter to them.

So I urge you to reconsider such an approach to money-management. Why let the government have your money? Why should you wait until the end of the year to get your money back, money that is rightfully yours?

If you are used to getting a big refund, make a change! You can control how much you pay in to the IRS during the year. If you or your spouse are W-2 employees (either of your own business or another business), you can change your withholdings very easily. Just file a new Form W-4 with your employer and you won't have to wait so long to get your money back.

If you are self-employed and making quarterly estimated tax payments, the same principle applies. Don't pay in so much that you get a big refund. With a little number-crunching you can determine the minimum amount of estimated tax payments you are required to make.