I’ve only recently joined the working force, and I am still not sure of this entire concept.
I know I am supposed to go to an accountant and show him a slip from my job for the returns, and also slips from my stocks that show all the net changes.
What I don’t understand is \*why\* I receive a certain amount after doing all of that.
In: 8
Tax refunds are the amount of taxes you overpaid and you are having them send that amount back to you.
You try to guess each year how much you will owe in taxes and try to have that much taken out in instalments. At the end of the year you figure out if you got it right. If you didn’t send enough then you owe the IRS money . If you sent to much then the IRS owes you money and you get a refund for that difference
By the way – it’s not a given that you will always get a refund: in certain circumstances you may end up owing money when you file your taxes. I know a lot of people feel that the refund is “the government giving you money”, but actually it’s you getting reimbursed for overpaying taxes through the year, at 0% interest. (I.e. if you get say $5K refund, then that’s like giving the government an interest free loan of $5k for 6 months).
Also – you do not need to go to a tax adviser to do your taxes. If you are in a job, and you maybe have a mortgage and do a few share trades then there’s lots of tax software products that can electronically file your taxes – e.g. TaxAct, TurboTax, etc. Not recommending or cautioning against any of them, but just pointing them out for your consideration.
The government essentially pre-calculates how much tax should be withdrawn from your salary. This is a “best guesstimate” based on what they know of your annual income and the tax rates that apply. Each pay cycle, the appropriate amount is withheld from your take-home pay, based on this ‘guesstimate’.
So the tax has already been withdrawn by the government. This is the important point here. They have *already taken the tax money from your salary*. But their ‘guesstimate’ may not be accurate. There are many ways in which a person’s actual income will be lower than the government estimate, or the amount of tax they should be paying is less than the government estimate.
In both cases, the government has *over-taxed* you, and needs to refund the difference in tax between their ‘guesstimate’ and your actual real income. This is the tax refund.
Each country is a bit different, but some common examples include:
* Not working for the entire year. Say the government sees that you earn a salary of “$120,000 per year”, but during that year you only actually worked 10 months and your actual income was really only $100,000. The government has over-estimated your income by $20,000 and taxed you too highly.
* Using losses from property or shares/stocks to offset your income. Say you earn $120,000 income but own shares that depreciated by $20,000. You may be able to use this to reduce your ‘actual’ income to $100,000. Again, the government has over-estimated your income and taxed you too highly.
* Making extra contributions to your superannuation/retirement funds. These are sometimes taxed at lower rates so can reduce your tax burden. e.g. Your salary is $120,000 and taxed at 30% but you contribute $10,000 to superannuation which is taxed at 15%. That $10,000 has had too much tax (30% instead of 15%) applied to it.
* Making contributions to charities or other organisations. These can be tax-deductible.
* If you had to spend your own money for travel, car fees, clothing, protective gear, laundry bills, etc that is directly related to your work. These are also often tax-deductible.
In all these cases, you can see the government has taken too much tax money from you and needs to pay some back.
Every year, you have a variety of options on how to file your taxes. You can file with the standard deduction one year, and then you can file an itemized set of deductions the next year. That is your right.
If you get married one year, and have a baby, that’s a major change in your deductions.
If your baby died and then you divorce, the next year you will file single with no dependents.
If you choose to take money out of your retirement account on the last week of December, that will be counted as income that is taxable (unless its a Roth account).
If you buy a house, that’s a BIG deduction, and will definitely affect your taxes.
The government has had trouble with some people not paying-in enough taxes, and at the end of the year they have to pay more money after they calculate what their tax is for the year. They want to avoid that, so things are set up so that you typically pay-in more than you will “probably ” owe.
Even so, you still have many choices about your tax filing, and neither you or the government know how much you have to pay them, or how much they have to pay you until you make those decisions and then officially file the tax return.
You go to a bar and hand the bartender a $100 bill.
You tell the bartender, “Here’s $100. Keep pouring me drinks, and we’ll square up the bill at the end of the night. If I drink more than $100 worth of booze, I’ll pay you the difference. But if I drink less than $100 worth of booze, you’ll give me a refund of the difference.”
Now, instead of giving the bartender $100 upfront for a single night’s worth of drinking, let’s say you give the bartender a portion of your paycheck every other week for your bar tab, and then you’ll square up the bill with the bartender at the end of the year.
Taxes work in the same way.
Every time you get a paycheck, some of your earnings are held back by your employer and paid to the government.
Every year, by April 15, you “square up your tab” with the govt.
You calculate your income, subtract your deductions, and then you’ll ultimately arrive at your tax bill. You take the total amount due, minus the amount you already paid in over the last year, and if you overpaid over the last year then you’ll get a refund.
Ideally the government already takes things like income tax out of your salary as you get paid. To do that they have to predict what your total income will be for the financial year. A tax refund is them overestimating it – it’s tax you shouldn’t have paid in the first place. If you got fired or took a pay cut, you might have overpaid those taxes and are eligible for a return. If you got a raise, or profited from other sources of income or investments like shares in a company that are impossible to predict, you may have underpaid taxes and owe money.
The government also wants to incentivize behaviour that benefits society or the economy. Eg. donating to charity, or buying products that help you work. To encourage that behaviour they will charge less tax on them. But these expenses aren’t predictable, and you already paid tax on them (in the form of income tax, sales tax etc). So you should declare them at the end of the financial year, then the government will refund the taxes you paid on them.
#ELI5
You owe taxes. That’s a given. We all owe taxes.
**How much?** Well that depends on tons of things. Some of those things are known ahead of time (like, what your salary is).
Some of those things aren’t known until the year is over. Nobody knows how much you donated to charity, but you. Nobody is keeping track of how many of your expenses were for work (like buying a uniform), but you.
**When do you pay taxes?** If you look at your paycheck, you will see that you’re paying them all year long. Your employer takes out some money every paycheck, and pays your taxes for you.
But your employer only *guesses* how much tax you owe.
The guess could be right, it could be wrong.
It could be wrong in two ways: Your employer could accidentally overpay your taxes, or could accidentally underpay your taxes.
So at the end of the year, you look at how much you earned, you look at all the things that would reduce your taxes (like buying uniforms), and you look at what your employer *already* paid.
If your employer overpaid, you get some back.
If your employer underpaid, you owe more.
MANY OTHER THINGS can affect whether you get some back or you owe more. I won’t go into that here. Just realize that there’s lots of things that can reduce the amount you owe, there’s lots of things that can increase the amount you owe, and we don’t know all of those things until it’s time to tally it all up at the end of the year.
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