It is time for a prison break!

http://www.youtube.com/watch?v=HmynbxyfFjM

This commercial offends every fiber of my being. The fact that they show a dancing black man, nearly makes me want to throw the remote control right through the television screen.  To compound that, they have the audacity to play the early 90s hit from Montell Jordan, This Is How We Do It.  Do what?

Who dances when someone pays them money that is owed to them?  Am I missing something?  Let me get this right.  This is as backwards as 3-2-1.

#3 – The GOVERNMENT took more of your money than what was required.

#2 – The GOVERNMENT then forced you to wait nearly a full year to get your money back.

#1 – The GOVERNMENT used your money for free since they did not pay you interest for use of your money – THEY DIDN’T EVEN SAY THANK YOU!

Are you mad now? Good — I want this to offend you the same way that it offends me.   

Education:

In today’s lesson, my principle aim is to get you to slam the breaks on Uncle Sam and his cohorts, who exploit you for your hard-earned money.  It is time for a prison break; let’s free your money from jail.

A tax refund is your money being released by the warden; in this case, the government is the warden.  Does the warden have the right to take what is rightfully yours and dictate the terms that he will give it back to you?  Right now, you are an inmate and the warden has given himself the right to your trust fund.

 

To make it plain, let’s look at how a tax refund is created.

Tax Refund = Money Withheld/Paid > Money Owed

My clients will attest that I actually prefer if they owe the government money at the end of the day.  That way, we are confident that there was no opportunity cost for any money that was paid in or withheld on their behalf.  Let me digress for a minute and explain the two main inputs in the above equation.

Money Withheld/Paid

Most employees are required to have their employers WITHHOLD (that means to separate and set aside a portion of your wages) income taxes from your paycheck.  This is not to be confused with FICA, which is also a tax, but it has no bearing on your income tax, except in a limited case, which is beyond the scope of this lesson.

Seems sensible? That crude example appears sensible, but it does NOT take into account any of your other factors such as –

• Do you own a home?
• Do you support an aging parent?
• Do you contribute to a retirement plan?
• Do you pay student loan interest?
• Do you contribute to a Health Savings Account?

Those questions and more would suggest that your projected gross wages are NOT equal to what your taxable income will ultimately be for the year.  That leads into the next topic.

Money Owed

Employees who earn wages are subject to tax on the income that they earn.  However, for tax purposes, income has a broader definition.  According to IRC Sec. 61, gross income is defined as, “all income from whatever source derived”.    You pay income tax on ALL income earned.  For most taxpayer, there total income is derived from their employment.

Each April 15^th, every taxpayer is called to produce a reconciliation report to the government (federal, state and local), which is the income tax return.  Most people know this report as their Form 1040.  The sole purpose of the report is to determine who owes whom at the end of the day.  It is nothing more than a contest.   There are winners and there can be losers. However, in my opinion, the losers are the unsuspecting taxpayers who allowed the government to hold their money without recompense.

Practical Application:

Let us return to the example discussed above.  In the example, Joan’s employer has no other information about Joan.  The employer does not know that Joan will NOT owe the government when it’s all said and done.  However, the employer withheld a total of $3,900 from Joan during the year.  Joan now has to file a tax return to get her money back.  What could Joan have done with that money during the year if it remained in her hands – this is called “opportunity cost”?

When Joan receives her refund, it will be for the exact amount that was withheld.  Translation – her money did not grow.  What if she could have invested that money and earned daily-compounded interest?  What if she could have put that money in a health savings account?  Maybe a bill came up during the year and Joan could have paid it off if she only had her money then.

The point is to change your perception about tax refunds.  I never want to see you dancing when you get a refund.  I want you to be angry and ask yourself, what could I have done to keep that money in my pocket?

Today’s players:

1. Government = Warden
2. People who dance because they get a tax refund = Inmates
3. Tax Refund = Tax-Free loan to Uncle Sam

 

Resources:

 

 

Important terms from this lesson:

Term	Definition
Tax Refund	A refund on taxes when the tax liability is less than the taxes paid.
Tax Withholding	Income tax withheld from employees’ wages and paid directly to the government by the employer.
Income Tax	Tax levied by a government directly on income, esp. an annual tax on personal income.

 

Action Step:  Read this lesson over and over until you are tired of being an inmate!