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Understanding Tax Returns and Tax Refunds: What You Need to Know
Tax season is largely defined by two important terms: tax returns and tax refunds. While filing tax returns may not be everyone’s favorite activity, the prospect of receiving a tax refund can be a welcome financial boost for many. Navigating the intricacies of income taxes is crucial for taxpayers seeking to optimize their financial outcomes during tax season.
Although the terms sound similar, tax returns and tax refunds represent distinct yet interconnected aspects of the annual tax process. A tax return is a document submitted to the IRS, detailing your taxable income earned throughout the previous year (and possibly your spouse’s income). This filing determines your income tax liability. Conversely, a tax refund arises when the amount withheld from your paychecks or reduced through deductions exceeds your total tax obligation. In such cases, the IRS issues the surplus back to you as a refund.
IRS Data on Tax Refunds
According to IRS data, over 42 million tax returns were processed by early March. Nearly 30 million of these filers were deemed eligible for a tax refund, with the total amount disbursed reaching approximately $102 billion. The average tax refund amount this year slightly surpasses the average observed during the same period last year.
Before anticipating a larger tax refund, it’s essential to understand circumstances where the IRS might reduce or seize your expected amount. However, it’s not all negative news. Taxpayers also possess certain options to manage and direct their refunds.
When Can the IRS Adjust Your Tax Refund?
Outstanding Taxes
One of the most typical reasons for an IRS tax refund adjustment is the presence of unpaid taxes from prior years. If you have existing federal or state tax debts, the IRS is authorized to use your current year’s refund to settle these obligations.
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For instance, if you owe $500 in federal taxes from a previous year and are due to receive a $1,200 refund this year, the IRS will deduct the owed amount, and you will receive a reduced refund of $700. In a scenario with a larger outstanding tax bill, such as $3,000, your entire $1,200 refund would be applied to the debt, decreasing your remaining balance to $1,800.
Unpaid Child Support
Similar to tax debts, delinquent child support payments can also lead to tax refund offsets. If you have unpaid child support obligations, the IRS can intercept your refund to cover these debts, operating under the same principles as with tax arrears.
Unemployment Compensation Debt
Debt related to unemployment benefits is another type of obligation that can be addressed through your tax refund. Unemployment debt accrues when individuals are overpaid unemployment benefits and are subsequently required to repay a portion or all of the excess funds received.
Your Options for Managing Your Tax Refund
While the possibility of refund adjustments may be concerning, especially for those in affected situations, taxpayers have some control over their refunds, particularly concerning how and where they are distributed.
Splitting Your Refund
Taxpayers have the flexibility to divide their tax refund across up to three different financial accounts, allocating funds in proportions as desired. Instead of directing the entire refund to a single bank account, this option allows you to designate portions for various purposes, such as contributions to retirement or health savings accounts. To utilize this feature, you need to complete Form 8888.
Offset Bypass Assistance
If you face a significant financial hardship and have outstanding federal tax debt (and no other state or federal agency debts), you might consider requesting an Offset Bypass Refund. This allows you to ask the IRS to refrain from using your refund to cover your tax debt for the current year. Eligibility is restricted to those with federal tax debt only.
There isn’t a specific form for this request. You must contact the IRS directly at 800-829-1040 or reach out to the Taxpayer Advocate Service. It’s crucial to act promptly, before the IRS processes your refund offset, as options become limited afterward.