Refund To Taxpayer Was Interest-Free Loan To Government Two-Thirds Of Filers Overwithhold During Year

Few people would argue the inequity of a financial arrangement in which one side gets to borrow money scot-free and the other is charged interest on unpaid bills.

Yet that’s essentially what happens to millions of taxpayers expecting refunds and to those still owing the government money.

“If you’re getting a refund, most likely the government is making money on your money,” said Marc Britton, director of personal financial planning for KPMG Peat Marwick in New York. “It’s a yearlong interest-free loan.” The Internal Revenue Service estimates 80 million taxpayers - or about two-thirds of the 120 million individuals who file federal income tax returns - overpaid their taxes by nearly $100 billion and are entitled to refunds this year. About 28 million taxpayers owe the IRS around $50 billion.

While most people openly welcome some extra green in the spring - an annual windfall they can use for investing, paying down debts or having fun - financial advisers often cringe at the thought.

That’s money, they say, on which individuals could have earned interest during the year instead of giving the government free access to it.

At the same time, they note, those who underpaid their taxes and are now being hit with a bill, are subject to interest charges, currently 9 percent, and possible penalties if they fail to pay in full by the April 15 filing deadline.

Those with sizable refunds most likely miscalculated their W-4 employer withholding allowances or overpaid their estimated taxes on income not subject to withholding.

The latter of the two is usually tougher to get a handle on since income varies year to year for people like the self-employed. For them, the experts say, it’s best to use the previous year’s income, deductions and credits as a starting point and to make regular adjustments accordingly.

It’s easier to control withholding allowances on the W-4 form filed with an employer. Each employee is permitted to take personal exemptions that free up specified amounts of wages from tax. The more allowances claimed on the W-4, the less income tax is withheld.

Several factors will determine the number of allowances, including marital status and household size. Any changes there should be promptly noted with an employer.

As a general rule, taxpayers should claim one allowance for every $2,500 in deductions taken on itemized returns, according to Mark Luscomb, chief analyst with CCH Inc., a tax law researcher based in Riverwoods, Ill. He suggests dual-income married couples calculate their combined allowances on one work sheet, then divide them among the W-4s that are filed with each employer.

So how close should taxpayers come in estimating their tax liabilities?

KPMG’s Britton and other financial advisers agree that a 10 percent margin of error is perfectly acceptable.