I Got A Tax Refund And I’m Not Happy About It

I’ve written about the often contentious topic of getting a tax refund before.  It was one of the first posts I did on my blog.  I wrote about it a second time detailing how much money you actually lose when you get a refund by factoring in inflation and the fact that most folks don’t receive their refund until well into the following year.

I’m not going to rehash my arguments here as to why getting a refund is a bad idea in multiple ways.  You can read those posts.  I also realize that many folks disagree with me even if they have to factually recognize the aspect of a refund as an interest free loan to the government.  Got it.

I’ve always underpaid my taxes on purpose, and then paid the balance to both the Federal Government and my state the following April.  It’s served me well and it allows me to take an interest free loan from those governments.  Additionally it has gotten me other financial rewards such as tons of credit card points when I pay back what I owe.

But I have a confession to make.  I screwed up my taxes for 2021 and didn’t follow my own advice.

Misfire

Regular Accidental FIRE readers know I have a graphic design business that started as a side hustle and has turned into something that funds a good portion of my overall expenses. 

Unlike many others with business income however I do not file quarterly taxes.  I have avoided that annoyance because I still have W2 income from my part time job.  As I detailed in this post I simply have the Federal Government and my state take out extra taxes from my W2 paycheck every month that approximate what I owe in taxes from my business income. 

The Feds and my state do not care how they get the taxes I owe, they just care that they get them.  And they probably like getting payments every 2 weeks instead of quarterly anyway.  It works like a charm. 

That is until it doesn’t. 

So the blogger who says it’s not wise to get a tax refund (i.e. – me) ultimately got a $1,100 refund from his state this year.  Yes I gave my state a $1,100 interest free loan in 2021.

Maths

I’m good at math.  But complex tax codes make it really difficult to use simple math to your advantage.  How did I make this mistake? 

It comes down to a pretty forgivable marginal tax bracket set up in my state.  As my business income has increased I have simply been increasing both the Federal and state deduction from my W2 paycheck to cover those taxes.  I assume that I’ll owe 30% of my business income to both of those governments. 

Well, that truth has held for the Federal government, but not for my state.  When I filed my annual tax return a few weeks ago it showed that I gave waaaay too much money to my state.  As my business income reached a certain threshold – above an beyond my W2 income – the taxes from my state did not increase. 

In short I overcompensated on the extra withdrawals to my state, by quite a lot. 

If This Is My Worst Problem…

Photo by Kelly Sikkema on Unsplash

I’m lazy.  I’m an index fund investor.  It got me to financial independence while allowing me to spend maybe 15 minutes in total dealing with my investments every year.  That’s something a day trader or stock picker cannot claim.  Time is money, and I enjoy spending it doing other things. 

But in this case my laziness cost me a bit.  I should have researched the tax brackets of my state better and seen that I didn’t need to increase my state withholding nearly as much as my Federal withholding to cover my business taxes.  And in the end I gave my state an interest free loan of $1,100. 

I just got that money back last week, direct-deposited into my checking account.  I can see why so many people like getting a tax refund.  Someone just pressed a button and $1,100 appeared in my checking account – woo-hoo!  Right?  Not really… 

As we all know that $1,100 refund is just me getting my own money back that I overpaid, without interest.  Inflation was well over 7% last year and is over 8% now so in reality I’m getting back way less than that. 

The kicker is that the S&P 500 went up a whopping 26.9% last year.  I could have had that money invested, working for me.  Instead it was working for my state government.

This experience does give me more understanding for those who simply get a refund every year because they just don’t want to deal with it.  But it’s still laziness in the end.  Laziness that costs money. 

Oh well, live and learn.  And I won’t make the same mistake going forward.