Fat Tax Refund? You Might be Giving Money Away

More than 75 percent of U.S. taxpayers had the satisfaction of receiving a refund from the Internal Revenue Service last year, but the truth is, getting that check should not be so gratifying.

Experts say millions of Americans are "over withholding," costing themselves hundreds of millions in lost interest and capital gains while giving the government a massive interest-free loan. When workers "over withhold," they give too much money to the government every week and don't receive any interest on the amount they're refunded when tax time comes around.

IRS data show taxpayers received almost $218 billion in refunds last year. That's an average of more than $2,170 for the 100 million workers who didn't get their withholding right in 2005.

Data from this tax season shows the problem is getting worse. So far, the 2006 tax year has seen refunds averaging $2,480 -- an astounding 14 percent increase in the average government tax payback.

Tax experts say increasing use of tax credits likely drives the refund glut.

What's a W-4 Form?

Employers in the United States are required to have workers complete an IRS form called the W-4 to determine the appropriate amount of taxes to take out of each paycheck. Workers often complete the form when they start a job and let that W-4 determine their paycheck withholding for too long. Tax experts say adjusting your withholding is important when you get married or have a child, when your salary changes, or when you gain supplemental income (like a rental property) or increase the number of deductions or tax credits on your annual tax filings.

The IRS automatically alters withholding levels when tax rates increase or decrease, but the tax agency doesn't take tax credits and deductions into account.

Things like child tax credits, student loan interest deductions and contributions to an individual retirement account can lower a person's tax burden but won't reduce the withholding from a person's paycheck.

The IRS says taxpayers should review their withholding status regularly.

A tax burden checkup is especially important if you have had a lifestyle change (such as getting married or divorced, or having a child), if your income increases or decreases substantially thanks to a second job or a working spouse, or if you have decided to take increased tax deductions or tax credits.

Making a change is as easy as filing a new W-4 form.

Ask Your Accountant for an Update

Taxpayers who use an accountant, paid tax preparer or tax software to file their returns should ask for an updated W-4 based on their 2006 returns. Most tax professionals will provide a completed withholding form in accordance with your current income and tax level. All you have to do is turn the new W-4 into your employer.

If you prepare your own taxes, you can change your withholding based on your refund or tax bill.

Taxpayers who receive a refund should increase the number of allowances they claim on their W-4. Allowances reduce the amount of taxes taken out of a paycheck.

Those who have to write a big check to cover their taxes should tell the IRS to take out additional money from each paycheck by adding an amount to line 6 of the W-4 Form.

The IRS offers printable W-4 forms and an interactive withholding calculator on its Web site, www.irs.gov.