You might have noticed that I have a few topics that I like to rant about. One that I have not discussed here, but that is very important to me is taxes. I ramble about what tax policy should be and what taxes should be used for and the fairness of the tax code and all of those exciting ideas, but that’s not the tax issue most important to me. It’s something much simpler and, more importantly, indisputable. Allow me to repeat so that the point isn’t missed: INDISPUTABLE. For on this topic, unlike how accurate some believe my other opinions to be, I am 100% correct on this. And you know why? Because I learned the framework in college. And you know what’s in college? Books!
From mid-January until April 15th, I get more worked up than I should by people who look forward to receiving their tax refund from the IRS. This is the most egregious mistake that an American taxpayer can make because it’s so easy to fix the situation. When a taxpayer receives a tax refund from the IRS, that worker has actually given the federal government an interest-free loan. I can think of better ways to use my money than lending it interest-free to the federal government for up to fifteen months. Even a simple money market account is better than a loan to the government. Consider ING Direct, which offers a 2.35% return with no fees and no minimum investment. That’s not spectacular, but it’s better than the 0% the federal government offers.
There are basic rules for paying your estimated taxes during the course of the tax year. H&R Block offers this advice on their Income Tax Basics page under the section “Withholding your taxes“:
Ideally, the amount of income taxes you have withheld from your income is equal, or close to equal, the amount of taxes you will owe for the year. If too much is withheld, a refund may be appealing but remember that a refund has a hidden opportunity cost: Instead of you earning interest on your income, you’re making an interest-free loan to the IRS!
From a link on that page, H&R Block offers this definition of “opportunity cost”:
Opportunity cost is the sacrifice of benefits from the next-best alternative that you face when you make a financial or economic decision. For example, say you had $1,000 to invest. You could invest it in a stock mutual fund that might return 20% or more. If you make this investment decision, you sacrifice the opportunity to earn a lower rate of return on an investment that has no risk. This might be a CD or other fixed-term deposit that had a 6% rate of return. This 6% guaranteed return would be the opportunity cost of investing in the mutual fund instead.
H&R Block “gets” the message but ignores their responsibility to advise (potential) clients with the next few sentences from the “Withholding your taxes” section.
On the other hand, if too little is withheld and you’re not prepared to pay at tax time, you may be forced to draw on your savings or, worse, pay with a credit card. To the extent possible, you want to optimize your withholdings to equal your estimated tax liability.
In addition, the IRS may penalize you if you have too little withheld. You’re required to pay at least 90% of your estimated tax liability for the year by Jan. 15.
I’ve already offered the solution for not having enough funds to pay the remaining tax bill, so there is no excuse for not claiming enough exemptions to avoid a refund. (The correct answer is one for yourself and another one for yourself, not including tax effects from investments, interest, etc.) Anything less is financially stupid irresponsible. H&R Block knows this, which makes their new contest absurd self-promotion at the expense of the people they claim to serve.
The contest is called The Double Your Refund Instant Win Game. Its basic premise is that, as the lucky winner, you can “double the amount of your federal refund up to $10,000”. Reinforcing the idea that receiving a tax refund is wise goes against all logic. The people getting refunds are generally going to be lower income wage-earners with the least complicated tax returns. These are the people most in need of better advice to help them make their paychecks go further. Yes, it’s beneficial for a single mother with three kids to get a refund of $1,200 each spring, but how much more helpful would that $1,200 be in $100 monthly increments over the course of the previous year? This contest doesn’t encourage customers to rethink their lack of a financial strategy, but it also fails to encourage H&R Block to teach their customers about developing a financial strategy. (Disclosure: I have no knowledge of how H&R Block conducts their tax preparation services, so they might teach their customers. I doubt it, but they might. I’m not saying they’re evil, just that this is a bad promotion.)
There is also another angle of this promotion that H&R Block doesn’t highlight. The minimum prize is $1,000, which is much closer to what the winner will receive than the $10,000 figure mentioned in the contest. Here’s a simple example to explain why. If a worker has no investments and claims the standard deduction (assumptions I’m making for the average customer of a simple tax preparation service) on a salary of $75,000 per year, that worker will owe approximately $14,000 in federal taxes for the year. That does NOT include FICA and state/city taxes. To receive a $10,000 refund, the example taxpayer would have to pay the IRS $24,000 during the tax year. Over-hyping a promotion is nothing new, but it’s illogical to promote a contest with the underlying assumption that the taxpayer will pay 70% more in federal taxes than necessary. All it signifies to me is that H&R Block thinks its customers are stupid.
That is what I rant about every spring. I’ve converted some people to the truth, but I’m still working on everyone else. If anyone still wants to hang on to illogical reasons for receiving a tax refund, I’ll get over it. I’ll secretly bang my head on the wall, but I’ll get over it. Thus, my simple version of everything I’ve just written is this: receiving a tax refund is bad. Learn it. Know it. Live it.
