What Is a Tax Refund?
The term "tax refund" refers to a reimbursement made to a taxpayer for any excess amount paid in taxes to the federal or state government. While taxpayers tend to look at a refund as a bonus or a stroke of luck, it often represents what is essentially an interest-free loan that the taxpayer made to the government. It’s often possible to avoid overpaying your taxes so you can keep more money in your pocket each paycheck—and avoid a refund when you file your tax return.
- If you get a tax refund, then you likely overpaid your taxes during the previous tax year.
- You may also receive a refund if you qualify for a refundable tax credit, such as the Earned Income Tax Credit, premium tax credit, or Child Tax Credit.
- Employees can avoid overpaying by accurately filling out their W-4s and ensuring that the information is current.
- Self-employed taxpayers can avoid overpaying by estimating their quarterly taxes with greater accuracy.
- A tax bill is the opposite of a tax refund, which you owe if your employer didn't withhold enough taxes from your pay.
Understanding Tax Refunds
It can be exciting to get a large tax refund. You can expect to get a refund if you overpaid your taxes during the year. This generally happens when taxes are deducted from your paycheck every time you get paid by your employer.
Here are some reasons why a taxpayer might get a refund:
- The taxpayer made an error in filling out Form W-4, used to estimate the correct amount of withholding from the employee’s paycheck.
- The taxpayer intentionally fills out their W-4 to have a higher withholding and larger tax refund at tax time.
- The taxpayer forgot to update their W-4 to reflect a change of circumstances, such as the birth of a child and an additional child tax credit (CTC).
- A freelancer or self-employed person who files quarterly estimated taxes may overpay to avoid a surprise tax bill or underpayment penalties at tax time.
- The taxpayer is eligible for refundable tax credits, which can reduce the amount of taxes owed below $0. In other words, if the credit is larger than your tax bill, you will receive a refund for the difference.
Tax refunds are the opposite of a tax bill, which refers to taxes owed by a taxpayer. In the case of a tax bill, you owe more taxes to the government than you paid during the year. You normally have a tax bill if your employer doesn't withhold enough taxes from your paycheck.
To avoid overpaying, you must fill out your W-4 correctly and update it if you experience a significant life change, such as marriage, divorce, adoption, a new freelance job or gig, the birth of a child, or a financial windfall.
Taxpayers are generally better off not overpaying their taxes in the first place because that money could be put to better use. For example, you could adjust your withholding (or estimated quarterly taxes, if you’re self-employed) and invest that extra money in your individual retirement account (IRA), 401(k), or even an interest-yielding savings account. That way, the money is working for you instead of for the federal government.
Refundable Tax Credits
Most tax credits are nonrefundable, meaning that the tax credit can only reduce a taxpayer’s liability to $0. Any remaining amount from a nonrefundable tax credit is automatically forfeited by the taxpayer. For this reason, this type of tax credit is sometimes called a wastable tax credit.
In contrast, a refundable tax credit pays out in full, meaning that a taxpayer is entitled to the entire amount of the credit regardless of their income or tax liability. If the tax credit reduces the tax liability to below $0, then the taxpayer gets a refund.
Refundable tax credits include:
Child Tax Credit (CTC)
The child tax credit is $2,000 maximum for eligible taxpayers. The fully refundable portion is $1,600 for 2023 and $1,700 for 2024.
Earned Income Tax Credit (EITC)
The Earned Income Tax Credit (EITC) gives low- and moderate-income workers and families a tax break. The credit is $7,430 in 2023 and $7,830 in 2024. The amount of credit that a taxpayer receives depends on their income, filing status, and the number of children they have. For example, eligible taxpayers who have no children will receive $600 for tax year 2023.
American Opportunity Tax Credit (AOTC)
The American Opportunity Tax Credit (AOTC) is a partially refundable tax credit that is available to taxpayers to offset qualified higher education expenses (QHEEs). If a taxpayer reduces their tax liability to $0 before using the entire portion of the $2,500 tax deduction, then the remainder may be taken as a refundable credit up to the lesser of 40% of the remaining credit or $1,000.
Premium Tax Credit (PTC)
Low- and moderate-income households may qualify for the premium tax credit (PTC), which lowers the monthly premiums for health plans offered through the federal and state health benefit exchanges. Taxpayers can use all, some, or none of their PTC in advance (i.e., upfront). If taxpayers use less PTC than they qualify for, they will get the difference as a refundable credit at tax time.
How a Tax Refund Works
Tax refunds usually are issued either as checks and sent by U.S. mail or as direct deposits to the taxpayer’s bank account. Alternatively, taxpayers can use the refund to buy U.S. Series I Savings Bonds. The fastest way to get a refund is to e-file your tax return and choose direct deposit.
Most refunds are issued within a few weeks of when the taxpayer files their tax return. However, there may be some instances where a refund takes longer.
For example, taxpayers who claim the EITC won't receive their refunds before March. That's because the law requires the IRS to hold on to these refunds until March due to years of fraudulent filings for the credit.
Refunds are always pleasant, but it would be better to avoid overpaying in the first place by correctly filling out your W-4 or precisely calculating your estimated taxes. The closer you get your refund to zero, the more money you will have throughout the prior year.
Of course, not everyone agrees. Some people consider tax refunds an alternative savings plan and look forward to the lump-sum repayment.
When Can I Expect My Tax Refund?
The Internal Revenue Service (IRS) claims that it issues “most refunds in less than 21 calendar days.” If you claim the Earned Income Tax Credit or the additional child tax credit, then your refund will arrive no sooner than early March.
Why Do People Get Tax Refunds?
You get a refund if you overpaid your taxes the year before. This can happen if your employer withholds too much from your paychecks (based on the information you provided on your W-4). If you’re self-employed, you may get a refund if you overpaid your estimated quarterly taxes. Refundable tax credits, such as the EITC, can also lead to refunds.
How Do I Check on the Status of My Tax Refund?
You can use the IRS’s Where’s My Refund? tool to check the status of your most recently filed tax return within the past two tax years. You can start checking Where’s My Refund? 24 hours after the IRS receives your electronically filed tax return or four weeks after you mail a paper tax return.
The Bottom Line
A tax refund is an amount of money that the government reimburses taxpayers who pay more than they owe in taxes. In general, it's a good idea to calculate the taxes that you'll owe as precisely as possible so that you don't overpay throughout the year. That way you can keep more of your money and put it to work for your best interests, whether that's earning a return and building your savings or paying off debt.