Every year, the vast majority of taxpayers are issued a tax refund. It may be tempting to treat yourself to a new TV or a tropical holiday, but before you do, you should understand what that windfall really is.
Both individuals and businesses pay a certain percentage of their income in taxes to the IRS, which uses that money to fund various activities and social programs. As an individual, your income tax is withheld from each paycheck by your employer (if you’re self-employed, you are the one responsible for paying your taxes).
Getting an income tax refund generally means that too much was withheld from your paycheck throughout the year. In other words, the government borrowed that money and is now issuing it back to you—without paying interest. And in most cases, that money would have served you better throughout the year.
For one, if you carry credit card debt, that extra income could have been used to pay off more of your balance and reduce your interest payments. Alternatively, you could have earned money by investing it.
However, some individuals still prefer a yearly “bonus” in the form of a tax refund, in which case we have a few suggestions for how it can best be used. For more details on each of these points, take a look at our original blog post.