Focusing on a Tax Refund? Do Some Planning Instead

Dear Carrie,

When I did my taxes last year, I wound up owing a lot to the IRS. A friend at work mentioned she got a huge refund. Can I do something to get a refund too?

—A Reader

Dear Reader,

Tax season always brings a host of questions from readers. Mostly they boil down to "How can I pay less in taxes?" or "How can I get a bigger refund?" But these are two very different questions. Here's why.

Tax refunds vs. how much you pay

Getting a refund doesn't mean you're paying less in taxes. A tax refund simply means you had too much withheld and, in effect, gave the government a zero-interest loan the prior year. In the same way, if you have to pay taxes when filing, it doesn't mean you're paying more. It just means you had less withheld than you owed the prior year. 

So rather than focusing on a refund, it may be prudent to focus on your total tax bill and what you can do to potentially reduce the taxes you pay. Here are some suggestions.

Check your withholding

To make sure you're not over or under paying, check to see if the right amount of taxes is being withheld from your income. You can do this with the IRS's Tax Withholding Estimator. It's important not to under withhold by too much as that can trigger a penalty as well as interest. Be sure to account for bonuses, investment income, and other income sources like rental income to ensure you're withholding the right amount. 

If you don't have taxes withheld, for instance if you're self-employed, an independent contractor, or have significant income from sources other than wages, you should be making quarterly estimated tax payments to the IRS to avoid penalties and interest.

Understand deductions

Deductions reduce the amount of income subject to tax. For some filers, itemizing deductions such as mortgage interest makes sense. But because of recent increases in the standard deduction ($12,950 for single taxpayers; $25,900 for married filing jointly for 2022, with those numbers going up to $13,850 and $27,700 in 2023), it's more practical for most filers to take the standard deduction rather than itemizing. (Good news for student loan borrowers: A portion of your interest on student loans can be deductible without itemizing.)

But whether or not you itemize, deductions aren't the only way to get a tax break.

Maximize contributions to tax-advantaged savings accounts

One way to lower your tax bill is to contribute to tax-advantaged accounts. For instance, tax-deductible contributions to traditional IRA, 401(k), 403(b), and 457(b) accounts can reduce your taxable income dollar for dollar. Roth IRA and Roth 401(k) contributions don't provide a tax deduction upfront, but still provide tax-deferred growth and the potential for tax-free earnings for qualified distributions after age 59½. The IRA contribution limit for tax-year 2022 is $6,000; the 401(k) limit is $20,500. Plus, individuals 50 and older can make annual "catch up" contributions of $1,000 to an IRA and $6,500 to 401(k)/403(b)/457(b) plans.

If you have access to a Health Savings Account (HSA), you get the advantage of 100% deductible contributions, tax-deferral, and tax-free distributions for qualified healthcare expenses now and in the future. This can be a great tax move. 2022 HSA contribution limits are $3,650 for an individual, $7,300 for families. Individuals 55 and older can make $1,000 annual catch up contributions to an HSA. 

Get (tax) credits

For many people, tax credits can be even more valuable than tax deductions because they offset what you may owe in taxes dollar-for-dollar. There is a wide range of tax credits available to all types of taxpayers. Some credits may not apply to you or may be phased out based on your filing status or income, but it's worth your time to do some research. Here's a list of just a handful of important (but often overlooked!) tax credits:

  • Earned Income Tax Credit—This is a tax break for families below certain income limits. For tax year 2022, the EITC ranges from $560 to $6,935.
  • Child Tax Credit—The maximum credit for 2022 is $2,000 per child up to age 16.
  • Child and Dependent Care Credit—Currently this credit is for up to $3,000 of qualifying expenses for one qualifying child or dependent; up to $6,000 of qualifying expenses for two or more. 
  • Retirement Saver’s Credit—Up to $1,000 ($2,000 for joint filers) in a government "matching" tax credit helps earners below certain income limits save more in a 401(k), 529 ABLE or IRA. (Note for the future: Under the new SECURE Act 2.0, in 2027 the Saver's Credit becomes a Saver's Match, with matching funds deposited directly in an individual's retirement account.)
  • American Opportunity Credit (AOTC) and Lifetime Learning Credit (LLC)—Designed to help with the cost of higher education, the AOTC is up to $2,500 per eligible student; the LLC is up to $2,000 per tax return. You can claim both AOTC and LLC credits on the same return—but not for the same student or the same qualified expenses. 
  • Premium Tax Credit (Affordable Care Act)—If you purchase health insurance through one of the exchanges created by the ACA, you may qualify for this tax credit to lower health insurance costs. 
  • Residential Energy Credit—If you're a homeowner who invested in energy efficient upgrades to your home, you may qualify for a credit equal to a percentage of the upgrade's cost.
  • Electric Vehicle Credit—If you bought a new, qualified plug-in vehicle (EV) in 2022 or before you may be eligible for a tax credit up to $7,500. 

Consider these strategies

Besides the opportunities discussed above, the following strategies may also help lower your taxes:

  • Bunching deductions—Certain deductions like charitable contributions and medical expenses are permitted if you itemize them. By "bunching deductions" in a particular year, rather than spreading them over multiple years, you may increase the likelihood of being able to itemize these costs. 
  • Tax loss harvesting—If you have investments in taxable accounts that have lost money, you may be able to use those losses to offset capital gains. Plus, you can deduct up to $3,000 of any remaining losses to offset ordinary income each year—and carry additional losses into future years. 
  • Donate appreciated assetsGiving appreciated stock or income-producing assets to charities may save on taxes and allow you to give more. 

As good as a tax refund may feel in the moment, that's not a sign you paid less overall. Instead of focusing on a refund, take the time to do some planning, making the most of tax-advantaged accounts as well as deductions and credits. Talk with a tax advisor for more specific advice and details. And once you've planned your strategy, consider E-filing for a quicker response from the IRS.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Schwab does not provide tax advice. Clients should consult a professional tax advisor for their tax advice needs.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.