What is a Tax Refund, How it Works, and How to Get It [2023]

Is receiving a tax refund a good thing or a bad thing?

Refunds mean getting your money back, hence the favorable reaction often associated with them. Contrastingly, when it comes to taxes, it may not always be something to celebrate.

Confused? Don’t be! This article will help you learn more about the tax refund, how it works, the pros and cons that come with it, and more!

What is a Tax Refund?

A tax refund is a type of remuneration resulting from overpaid federal or state income taxes. Reimbursing taxpayers often takes place because an excess amount is withheld from their salaries by their employers.

Refunds in taxes are sent to the taxpayer as a check or as a direct deposit to their account. For taxpayers, receiving tax refunds gives them an extra boost to cover a good chunk of their expenses.

These expenses include paying off student loans, credit card debt, or retirement savings.

In reality, tax refunds are considered interest-free loans taxpayers make to the government. While it may present financial leeway for taxpayers, it also underscores a prevalent habit of mismanaging finances.

How Does a Tax Refund Work?

Tax refunds are usually sent to the taxpayer a couple of weeks after their annual tax returns have been filed.

Annual tax returns provide substantial information on how much taxes you owe, along with any refunds you may be entitled to. Keep in mind that the timeline for receiving tax returns will vary depending on how you file your tax returns.

Some taxpayers who qualify for a tax refund use the reimbursed amount to purchase US Series I Savings Bonds, safe and non-marketable investments that merge fluctuating inflation rates with fixed interest rates.

Savings I Bonds have a guaranteed return rate of up to 6.89%, making it a viable choice if you want to maximize how you use your refundable tax credits.

Refundable Tax Credit

Refundable tax credits refer to credits reimbursed to taxpayers, regardless of any existing tax liabilities.

The different types of refundable taxes are as follows:

#1. Child Tax Credit (CTC)

The Child Tax Credit (CTC) is a tax credit meant to support parents or guardians with 17 year old or younger dependents.

Under the CTC, eligible parents earning $400,000 or less on modified adjusted gross income (for married people filing jointly) or $200,000 (for single filers or heads of household) are to receive up to $2,000 worth of credit per qualifying dependent.

Parents may claim their CTC by filing their Form 1040 or 1040-SR and their Schedule 8812. The IRS typically releases the Child Tax Credit in mid-February. Early filers can expect updates on their CTCs around February 18 and February 28.

#2. Earned Income Tax Credit (EITC)

Earned Income Tax Credit (EITC) is designed to compensate for the earnings of low-wage workers. Using a dollar-for-dollar basis, the EITC effectively reduces the tax owed by low-income workers and minimizes the impact of Social Security taxes on their gross earnings.

Dubbed a “work bonus plan,” EITC’s qualifications are reserved only for low to moderate earners. For the 2023 tax year, the tax credit ranges from $600 to $7,430, depending on the worker’s filing status and the number of dependents.

If a worker does not have children or dependents and plans to file an EITC claim, they must be aged anywhere between 25 and 65 years old to qualify.

#3. American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) benefits students enrolled in higher education. It aids in covering educational expenses for the first four years of their academic careers. According to the IRS, eligible students can claim a maximum of $2,500 for AOTC.

Students who want to qualify for the AOTC must not have completed the initial four years of higher education at the start of the tax year. They must also pursue a degree or any other accepted scholarly credential.

Eligible students must receive Form 1098-T (Tuition Statement) from a qualified academic institution to claim their AOTC.

#4. Premium Tax Credit (PTC)

Premium Tax Credit (PTC) helps reduce the costs of insurance premiums for taxpayers who signed up for health coverage through the Health Insurance Marketplace.

Credit amounts under the PTC depend on the taxpayer’s household information and estimated gross income. In addition, the IRS assesses the taxpayer’s household size to check whether their income falls anywhere between 100% and 400% of the federal poverty line.

If a taxpayer wants to qualify for the Premium Tax Credit, they are not allowed to qualify for any other health care plan, especially through their employer or the government. Only health coverage acquired through the Health Insurance Marketplace is accepted under PTC.

Tax Refund Pros and Cons

Tax refunds come with advantages and drawbacks. Let’s explore them one by one.

Tax Refund Pros

• Supplements your savings. With the prices of basic commodities increasing due to inflation, it can be challenging to cut costs consistently. Tax refunds can serve as an added monetary resource that you can add to your savings.
• Provides extra cash. In case there is an emergency, your refundable tax gives extra cash that you can use to cover any unforeseen expenses. You can also use your tax refund to pay off debts.

Tax Refund Cons

• Inaccurate tax withholding. You get refunds in your taxes because you paid them excessively. This could also mean that your employer is overwithholding a percentage of your gross income. Thus, you tend to receive less on your net income.
• Mismanaged finances. By continuously committing errors in calculating your taxes owed, you are causing a domino effect of imbalance in your expenditures. It is better to pay the right amount of taxes so you can receive a higher salary and not worry about any discrepancies with your taxes later on.

How to Get a Tax Refund

File your annual federal income tax return to get a tax refund. You must include your Form W-2 along with the 1099 and 1099-INT forms.

Aside from the aforementioned forms, you must also double-check your filing status. Your filing status and the percentage you spend on household expenses directly influence how much you will receive in your tax refunds.

You can also use tax preparation software to help eliminate tax filing errors.

When Can You Expect to Get a Tax Refund

Tax refunds are available in as little as 21 days, provided that the IRS does not encounter any errors or discrepancies in your annual tax return. However, if there are inconsistencies, you can expect a longer waiting time before receiving your refund.

You have two options on how to claim your tax refund: One is to request a paper-based check through the mail. Another option is to have your refundable tax deposited directly into your bank account.

It takes a maximum of eight weeks to receive tax refunds if you file tax returns on paper. In contrast, electronically filed tax returns will take 3 to 12 weeks.

If it takes longer than eight or 12 weeks before you receive your tax refund, there may also be other factors you need to consider, such as:

• The type of tax return filed. Earned Income Tax Credit (EITC) takes longer to process because it has been notorious for countless questionable filings. Hence, the law mandates the IRS to keep hold of refund requests until March.
• Errors in calculating or filing tax returns. The IRS might have to verify some information to assess whether you qualify for a refund.

How to Check the Status of Your Tax Refund

The IRS offers online tools that help you track and check the status of your tax refund. These tools are the IRS2Go mobile app and the Where’s My Refund tool.

IRS2Go is the IRS’s mobile app that allows users to check their refund status, send direct bank account payments and debit and credit card payments to pay for taxes, and access the tax software for free.

The Where’s My Refund Tool assists taxpayers in checking the status of their income tax refund.

Final Thoughts

It is crucial to be extra careful when settling your taxes. Although tax refunds provide some advantages, they may potentially leave you with additional responsibilities and unwanted financial burdens in the long run.

Ensure that you fill out your Form W-2 correctly, provide the correct filing status, and use available tax calculating tools to estimate your withholding tax rates more accurately.

Lastly, coordinate with your employer to see whether the correct percentage is being withheld from your gross income. Who knows, you might not be reaping the fruits of your well-deserved net income fully simply because your employer holds more than the necessary amount from your gross paycheck to settle your taxes.

Key Takeaways

• A tax refund is a refundable credit that is given to taxpayers who have paid an excess amount in their withholding tax.
• Taxpayers must file their annual income tax return and submit their Form W-2, 1099, and 1099-INT forms to get their tax refund.
• Refundable tax credits are adjusted payouts or credits to taxpayers that are not influenced by any existing tax liability.
• Examples of refundable tax credits include Child Tax Credit, Earned Income Tax Credit, American Opportunity Tax Credit, and Premium Tax Credit.
• The IRS offers tools such as the IRS2Go mobile app and the Where’s My Refund tool to monitor the status of tax refunds.