We’ve all been guilty of it – we get a big tax refund check and run out to buy that big-screen plasma television we’ve been wanting, or take a trip to Mexico, or that new sofa you’ve been dreaming of adding to your sun room.
Spending your tax refund check this way is one of the worst things you can do.
The first thing you need to understand is that your tax return is, in fact, your money to begin with! It’s not some gift from the government; rather, it’s money that you overpaid to the government over the course of the previous calendar year.
If you consistently receive a hefty tax return each year, then you are doing nothing more than giving the federal government an interest-free loan on your money. There is no reason to do that. The solution? Adjust your federal income tax withholding so that you neither owe, nor receive a substantial amount of money come tax time each year.
But if you do end up getting a big refund check, here are 3 simple yet financially sound ways to spend it.
1. Eliminate Credit Card Debt – First and foremost, if you are in any sort of credit card debt, pay it off! When you’re paying interest fees for any credit card, you’re just giving away your hard-earned money. Forego any other temptation with your tax return until you have completely eliminated credit card debt from your life. Once you’ve done that, stay away from credit card debt altogether. There is a simple rule to follow – if you can’t afford to pay it off by the end of the month, then you need to drastically reduce your spending habits.
2. Invest 75% – If you don’t carry a credit card balance, consider the following formula: Each year, commit to investing 75% of your tax return check. The investment products you choose are up to you. You can utilize a Roth IRA or a traditional IRA as you work to save for retirement, or you can build up an emergency fund to protect you against unforeseen events that come your way. You can also choose to invest a portion of your tax refund money in some of the riskier investment options like investing in the stock market or trading financial derivatives. Whatever you choose, the important thing is they help stabilize your future income rather than fulfill any short-term temptations.
3. Spend 25% on Yourself – If you’ve led a financially stable life over the course of the past year, there is nothing wrong with spending some of it on yourself or on projects that have been tossed to the side. Exactly how you spend it is up to you, but rewarding yourself from time to time with small splurges during your financial life is pertinent to your overall success. Indulge yourself if you want, but just make sure you do it after you’ve invested the first 75%.
If you do get a large refund, by all means enjoy some of it. Simply put, prioritize your debts and your future income before spending the remainder on any short-term purchases. Your tax return should be used as one of your many tools towards achieving a fiscally responsible lifestyle. Use it to your advantage! Then, as you get out debt and invest more and more, you can begin rewarding yourself.
How are you going to spend your tax return money this year? Do you have any other tips that have worked for you? Please share your comments below.
The following is a guest post from Richard Barrington who writes for MoneyRates.com about financial topics including bank rates. His opinions do not necessarily reflect those of our company.
Before you think about how qualified your tax preparer is, think about what’s riding on your tax return.
On the upside, good tax advice can save you hundreds, or possibly thousands, of dollars in tax liability. On the downside, tax evasion is punishable by up to five years in prison and a $250,000 fine, and YOU are responsible for your tax return, regardless of how you file your taxes or who prepares it.
Hardly any states license tax preparers, so it will most likely be up to you to determine whether your tax preparer is properly qualified. Here are six things you should know before hiring someone to do your taxes for you:
What are the preparer’s professional qualifications?
According to the Bureau of Labor Statistics, most tax preparers don’t even have a bachelor’s degree. However, only a CPA, Enrolled Agent (a federally-authorized tax practitioner), or attorney can represent you in front of the IRS in an audit or other proceedings, so looking for a higher level of professional qualification might be worthwhile.
Is this a full-time occupation?
Tax work is somewhat seasonal, but changes to the tax code and case law can happen throughout the year. You don’t want your tax preparer to miss valuable income tax-deductions because they’re not up to speed on recent changes. Also, your questions or inquiries from the IRS can occur at any time, so you might be better off with a full-time tax specialist.
Will the work be delegated down to someone else?
Is the person you meet face-to-face preparing your returns, or is this delegated to someone else? If the work is delegated, you want to know something about the process. In particular, the IRS cautions against firms that outsource the work to foreign countries, where privacy laws may not give you as much protection as they do here in the U.S.
What type of firm is it?
Good tax preparers can be found in anything from sole practitioners to multi-national accounting firms. There are trade-offs to each one. With a major accounting firm you get a widely-known reputation and deep resources, but you’ll probably pay more for a big-name firm. A smaller firm may be more personal and less expensive, but have less resources to put into the preparation of your return and backing you up if the IRS calls.
What is the preparer’s reputation?
Check out anyone you hire with your local Better Business Bureau. If your tax preparer has specific professional credentials, there may be other avenues for checking up on them, such as your state’s board of accountancy for CPAs, your state’s bar association for attorneys, and the IRS Office of Professional Responsibility for Enrolled Agents. http://www.irs.gov/taxpros/agents/index.html
If your return is prepared by an individual or firm that has had run-ins with the IRS, it might be a red flag drawing special attention to your return, so reputation matters. Tax preparers are easy to find, but it’s worth a little extra effort to find one who is properly qualified.
What is the preparer’s audit history?
This is a tricky one. It’s good to have a preparer who has some experience with the IRS audit process, but not so much experience to suggest they produce questionable returns. Perhaps the key is to know the outcome of those audits–someone who has had returns stand up under audit may be the ideal choice.
Just because you have to file your taxes doesn’t mean you have buy software… pay a professional… or necessarily do it yourself.
Have you filed your 2010 taxes yet? Did you pay someone to do it, or do it yourself? We’d love to hear from you. Just click the comment link below to sound off.
The average tax refund last year was $3,000. Do something smart with that money.
Are you getting a refund this year? What are you planning to do with it if you are? We’d love to hear your plans. Just click the comment link below.
How does the IRS select returns for an audit? Stacy Johnson explains…
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