What is a Tax Refund?

A tax refund is an amount of money that the government pays back to you, usually because you initially overpaid your taxes. Tax refunds can be issued for a plethora of reasons, but most commonly they are issued simply because you paid the government too much in tax money over the year. If you have paid the IRS more money than your tax liability comes to, you will be issued a tax refund so that you can claim this excess back. For example, if your tax liability for the year is $2,500 and you pay $3,000 in taxes, you will receive a tax refund worth $500, assuming you have no tax credits or deductions to apply.

Salaried employees may often receive tax refunds when their employer withholds too much of their salary for tax reasons. Employers don’t always factor in employees’ individual circumstances when withholding tax money, often applying standard tax withholding rates to all employees. Some employees will have tax credits or tax deductions that will decrease their overall tax liability, and these employees should let their employers know about this in order for their tax withholding to be adjusted appropriately.

If you are paying too much in tax, you can also update your W-4 IRS Form in order to reduce your withholding. This gives you more take-home pay with every paycheck, and may reduce or completely eliminate your tax refund altogether. Be sure not to reduce your withholding too much, however, or you may find that you will OWE the government tax money by the end of the year.

Sometimes taxpayers will also receive tax refunds due to refundable or partially-refundable tax credits. Refundable tax credits are tax credits that can reduce your tax liability to zero, whilst still paying you any excess money as a tax refund. For example, if you owe $750 in taxes but have a $1000 refundable tax credit, the IRS reduces your liability to zero AND pays you the remaining $250 in the form of a tax refund. Partially-refundable tax credits work similarly, but you may only receive a portion of any excess money.

It should be noted that you have a limited timeframe in which to claim a tax refund. Usually, this limit is within 3 years of you filing the relevant tax return, or within 2 years of you paying the tax – whichever date is later. Be sure to claim your tax refund within your applicable timeframe, otherwise your tax refund will be written off and you won’t see a penny of the money that the government owes you.

While many people may rejoice at the notion of receiving a tax refund, it is important to remember that this is simply money you could have had during the rest of the year. Properly calculating and adjusting your tax withholding allows you to harness the majority of your take-home pay over the year without having to wait around for an annual lump sum that is rightfully your money in the first place.