The IRS and Income Tax Refunds: Will They Pay or Will I Owe?

Tax season is just around the corner, which means it’s that time to ask yourself a familiar question: will I owe money, or will I get a refund? It’s one of the most commonly asked tax questions, so it’s a good idea to fully understand how the IRS determines whether you owe them or they owe you.

First, it’s crucial to understand that when you file tax returns this year—2022—you are filing tax returns based on income earned from Jan. 1, 2021 to Dec. 31, 2021. Then, based on the amount of taxable income your household had, your household pays a certain percentage of that income to the federal and state governments (note* some states do not have income tax).

Second, most people choose to have these taxes taken their paychecks incrementally over the course of 2021 in the form of tax withholdings. This is to ensure they don’t owe a large sum come April of 2022. This is standard practice for working Americans.

Now, there are two crucial points to understand. One, the amount of taxes you are obligated to pay does not change if you choose to withhold taxes throughout the year or you choose to pay all your taxes the following April, only the timing of your tax payment changes. Two, even if you choose to withhold taxes throughout the year—done by filling out form W4 with your employer—the amount of taxes being withheld is seldom an exact figure. In other words, you might have withheld too much or too little over the year.

This is where the refund part comes into play. What, exactly, is a refund in everyday life? It’s the return of a payment that you were not actually required to pay in the first place. A tax refund is no different. If you owed the IRS $10,000 for 2021 taxes but you gave it $11,000 over the course of the year, you will receive a $1,000 refund in the spring of 2022, after you file your return.

Conversely, if you owed the IRS $10,000 for 2021 taxes but only gave it $9,000, you will owe the IRS an extra $1,000 when after you file your return. The $10,000 amount owed does not change. This is the common misconception of a tax refund: if you receive money back from the IRS, it is not extra money, but, rather, it has been your money all along, the IRS is simply returning it to you several months after you gave it to them.

In essence, receiving a tax refund is simply getting the money back that you temporarily lent to the IRS or your state government. It’s more of an emotional gain than a financial gain since you didn’t actually receive extra money, but, understandably, people would much rather receive money than owe money each April 15. To avoid an unpleasant tax surprise in April of 2023, make sure you withhold a sufficient amount of federal and state income taxes from your paycheck in 2022.

A handy IRS link will help you get your withholdings correct.

Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.

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