The Dangers of Big Tax Refunds

03 Oct The Dangers of Big Tax Refunds


75% of tax filers get a refund. And the average refund amount is over $ 2,300. I was surprised by these figures. Am I the only one not getting an “annual bonus” from the government?

What is wrong with getting a refund check, and what does it have to do with filing for bankruptcy? Plenty.

Can you imagine your employer not paying you the full compensation earned? What would you do if he held back a few hundred dollars every month and promised to make up for it later? Nobody would tolerate this. Lawsuits would be filed.

But when it comes to income taxes, most people don’t mind overpaying the government as long as they can square things up each April. They even look forward to the annual refund as a forced savings program. Many who get large refunds treat it as “found money” and don’t associate it with the unnecessary economic stresses suffered the prior 11 months.

The problem with a tax refund is that you short-change yourself every payday in order to get one. A $ 4,800 tax refund sounds exciting, but if you have to live $ 400 poorer every month, it is not worth it. For families that live paycheck to paycheck, $ 400 a month makes a big difference.

My advice . . . . don’t pay more in taxes than you need to. Good financial planning involves understanding your true monthly income and expenses. If you received a big tax refund this year, you should take steps to adjust your withholdings. You can adjust your withholdings using Form W-4.

The more exemptions claimed on a W-4, the less taxes taken, and the smaller your refund come April 15th. Your goal should be to increase your monthly take-home pay and break even at the end of the tax year. You are most efficient when you neither owe taxes, or are owed a refund for overpayment.

For those filing a Chapter 7 bankruptcy, your latest tax return is given to the assigned trustee. She will examine the amount of your refund to see if you are artificially suppressing your pay . . . . . and big tax refunds are a red flag. She may assume that you will be getting another tax refund this year and that you have more discretionary income than what you disclosed in Schedule I. A good bankruptcy lawyer will factor this into your petition before filing your case.

In a Chapter 7 case, a debtor must prove that his monthly living expenses (not including credit card payments) exceed his monthly net income. For the debtor who gets a $ 4,800 refund, he will need to make sure that his expenses exceed his monthly income by at least $400 ($ 4,800/12). Unless he adjusts his withholding, or accounts for the refund in his income calculation, he may be forced into a Chapter 13 five-year repayment plan.

If you rely on tax refunds or credit cards just to survive, you should contact an experienced bankruptcy attorney for help. Bankruptcy protection laws are powerful and may be an option you should explore.

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