Tax Refund Accounting

[David1961]

I have been FIRED for almost 5 yrs and do a pretty thorough job of tracking my expenses. In my system, I consider taxes as an expense that I track like other expenses. This year, I am getting a tax refund so I guess I will handle this like a negative expense. Never have done that, but makes sense. If I owed the money, it would be an expense so shouldn't getting a refund be a negative expense? Are there any downsides of doing this that I havent thought about? Besides knowing that I have loaned Uncle Sam money for no interest, it's a good problem to have and should lower my withdrawal rate some this year.

 

[socca]

Are there any downsides of doing this that I haven't thought about?

For budgeting purposes, the only number that matters is your estimated tax liability. In order for my bank accounts to reconcile in Quickbooks, I need to enter estimated tax payments made and refunds received as they occur. However, this info isn't useful when it comes time to prepare my annual budget.

 

[Texas Proud]

Yes, I treat it as a negative tax....


However, I also get a refund of the ACA credit on my return and I treat that as a negative insurance cost... don't want to mix where the refund should go....

 

[audreyh1]

If you have a category named something like "Federal Taxes" where you track taxes paid, then treat it like a refund in that category. Refund = negative expense, sure!

 

[Cobra9777]

Some people consider income taxes to be a direct reduction of income. I've seen that posted here from time to time, and that's sort-of how it felt when I was working. So I assume they would treat the refund as additional income.

I think most people consider taxes to be an expense, so a refund would be negative expense in the year it is received. Technically however, it relates to the prior year, so under accrual accounting, you would have recorded the credit in the prior year, along with a tax refund receivable. Then, when the cash arrives the following year, you would reduce the receivable with no impact on expense. Of course, no one does that. We all use the cash flow basis in our personal finances, so we have to deal with timing issues.

In my year-end expense analysis, if I know there's an unusually large tax refund or payment due, I'll make an adjustment "as if" the estimated payments were perfect, so that I remove any payment timing issues from the true variance on taxes vs plan. However, we have no withholding of any kind and make quarterly estimated payments. So I control the over/under very closely. We usually owe a small amount with the return that *just* avoids a penalty, and it is very similar every year. So the adjustment is not really necessary and I usually just treat the small amount I owe with the return as additional tax expense in the year paid.

 

[jebmke]

I just track taxes from the returns. You don't need to worry about whether there is a refund or not. The return will show the actual tax.

 

[Fedup]

I treat it as a bonus. Forget all these tax accounting terms bogus.

 

[scrabbler1]

Some people consider income taxes to be a direct reduction of income. I've seen that posted here from time to time, and that's sort-of how it felt when I was working. So I assume they would treat the refund as additional income.

I think most people consider taxes to be an expense, so a refund would be negative expense in the year it is received. Technically however, it relates to the prior year, so under accrual accounting, you would have recorded the credit in the prior year, along with a tax refund receivable. Then, when the cash arrives the following year, you would reduce the receivable with no impact on expense. Of course, no one does that. We all use the cash flow basis in our personal finances, so we have to deal with timing issues.

In my year-end expense analysis, if I know there's an unusually large tax refund or payment due, I'll make an adjustment "as if" the estimated payments were perfect, so that I remove any payment timing issues from the true variance on taxes vs plan. However, we have no withholding of any kind and make quarterly estimated payments. So I control the over/under very closely. We usually owe a small amount with the return that *just* avoids a penalty, and it is very similar every year. So the adjustment is not really necessary and I usually just treat the small amount I owe with the return as additional tax expense in the year paid.

When I figure out my year-end summaries, I may end up combining tax payments which were applied to different tax years. This can include 4th quarter estimated tax payments due 1/15/yyyy in either year yyyy or year yyyy-1, depending on when I actually made the payments. This doesn't usually cause a distortion as the amounts in question are fairly small. Sometimes I have "bunched" these taxes so I made two 4th quarter estimated tax payments within the came calendar year.

I did make one exception to this, and it was for a very large April tax payment for the previous tax year which had a very large lump-sum income from cashing out my company stock. Had I included it in the following year's summary, it would have totally distorted that summary because it was for more money than I had earned the entire year, my first year in ER. Instead, I netted it out against the prior year's income which included the large, lump-sum income.

 

[Alan]

I don't keep a very detailed expenses spreadsheet but I do have a line item for Fed and State income taxes and update it each month with the withholdings and estimated tax payments. (The January estimated payment goes into the December of the previous year).

When I get a refund or have to pay when I file my taxes I update the previous year's expenses.

 

[sengsational]

Rather than a negative expense or income, you could treat it as an asset: a loan that you hold.

Say for example that you are unable to remove funds from a 401k without paying 20% withholding. You remove $50K, and now your net worth of $1M dropped instantly to $990K? No, not even close. If you really owed the $10K, then maybe one might argue you paid an expense early. But let's say you're not going to owe any tax.

What I would say is you create a loan account (asset) on your books in the amount of the withholding: $10K. Even if you end up owing some tax, you don't owe it when you pulled the money, you owe it on April 15 of the following year. At that point, it becomes an expense. In the mean time, they're simply holding your money.

 

[Danmar]

Some people consider income taxes to be a direct reduction of income. I've seen that posted here from time to time, and that's sort-of how it felt when I was working. So I assume they would treat the refund as additional income.

I think most people consider taxes to be an expense, so a refund would be negative expense in the year it is received. Technically however, it relates to the prior year, so under accrual accounting, you would have recorded the credit in the prior year, along with a tax refund receivable. Then, when the cash arrives the following year, you would reduce the receivable with no impact on expense. Of course, no one does that. We all use the cash flow basis in our personal finances, so we have to deal with timing issues.

Yes, as you point out taxes can be difficult to budget for. I treat them as an offset to income but either way, the mismatch between when the taxes are incurred and when they are paid can be an issue. My pension is tax withheld but for some reason they under withhold. Took me a while to figure this out and budget for it.

The real problem is tax instalments because these are based on previous years' tax owing and may not reflect current taxes actually owing. If I realize some cap gains or gift some appreciated stock it can have a big effect on instalments required. I could reduce my instalments accordingly but then would risk penalties if I realized gains near year end. Forecasting these items out 3 years can be a little tricky especially if tax rates change (they have increased quite a bit in Canada).

Have considered the true "accrual" method you describe but so far have stuck with the cash (ie as paid) method.

 

[audreyh1]

Right, I can't predict my taxes year-to-year. So I don't include them in my budget. I simply estimate my taxes still owed at the end of each year, and from that estimate my quarterly tax payments for the coming year using safe harbor rules. Take my withdrawal, set aside the estimated amount for taxes to be paid during the year, and the rest is my after tax income.

My income changes every year as well as my taxes, so not until Jan do I have an idea what my after tax income is for the year, and then I figure out how that matches my "usual" budget and what adjustments need to be made. Lots of discretionary spending in the budget so it's very flexible.

When I file my taxes, I adjust the funds set aside for the taxes to be paid during the remaining year (3 payments for the current year estimated taxes).

If I have overpaid estimated taxes, I usually know that by the end of the year, so I adjust my 4th Jan tax payment (which comes out of the new year income) to correct for that somewhat.

It works.

BTW - if I think there is going to be a huge discrepancy in estimated tax payments based on prior year taxes and the taxes owed for the coming year, I can switch to the annualized income method at any time during the year and reduce the taxes paid. But I still have to leave the funds set aside for taxes until I know for (pretty) sure at the end of the year. If I've set too much aside, this is corrected at the start of the next year.

 

[audreyh1]

The real problem is tax instalments because these are based on previous years' tax owing and may not reflect current taxes actually owing. If I realize some cap gains or gift some appreciated stock it can have a big effect on instalments required. I could reduce my instalments accordingly but then would risk penalties if I realized gains near year end. Forecasting these items out 3 years can be a little tricky especially if tax rates change (they have increased quite a bit in Canada).

Do you have an annualized income method for estimated taxes in Canada?

It's a lot more work, but is an option in the US which can work well if taxable income is "lumpy" throughout the year. And you won't be penalized as long as you paid taxes for the actual income received each quarter. I mainly use it if I know that the current year income is going to drop significantly because I did something unusual like realize a large cap gain the prior year. Most of my taxable income shows up in December, so I could do this (extra work) every year, but since I already set aside funds for taxes based on prior year taxes owed, I tend to pay them in even quarterly installments and wait to resolve any discrepancy until Jan of the next year.

 

[LOL!]

How do you treat the thousands of dollars of cash-back money from your credit card?

 

[bingybear]

If I got a tax refund and the information was not needed for next years taxes... I'd ignore the record keeping and either save, spend or invest the refund itself. If I left it with the government as part of estimated tax, they I record it in a spreadsheet that will be used for next years taxes.

If I want to figure out what I paid in taxes, I go back and look at my tax forms... usually in electronic form.

I don't do detailed accounting of everything. I know, heresy. I just do mental accounting. For me it is close enough for now and I've done it all my life.

I know people who have a list and accounting for everything they do. That is fine if they need it. Some of them I've found have done this all their life. I'm just not there yet.

So I don't account for just a tax refund. Account for it however you like and us the data however you will. My only concern for getting a tax refund is that the check cashes in a somewhat timely manner and in my account.

 

[bingybear]

How do you treat the thousands of dollars of cash-back money from your credit card?

funny. I don't. I either spend it or invest it. That usually depends which card provides the cash back. One deposits into an investing account. The others turn into statement credits and are used in normal spending.

I'd have to go thru online statements to find the number.

 

[mystang52]

Treat it as found money - spend it on some selfish "non-practical" item, save it, go out for a nice dinner, whatever floats your boat.

 

[scrabbler1]

How do you treat the thousands of dollars of cash-back money from your credit card?

When you write "treat," do you mean what we do with it or how we handle it in our bookkeeping?

My cash rewards are pretty low, maybe $50 a year. The money gets sent back to my linked (to the CC) checking account which ultimately pays the CC bill, so I treat it as a negative CC payment. I don't use it specifically for spending purposes although it may end up getting invested elsewhere if my checking account has enough excess cash (over the minimum balance) in it.

 

[Danmar]

Do you have an annualized income method for estimated taxes in Canada?

It's a lot more work, but is an option in the US which can work well if taxable income is "lumpy" throughout the year. And you won't be penalized as long as you paid taxes for the actual income received each quarter. I mainly use it if I know that the current year income is going to drop significantly because I did something unusual like realize a large cap gain the prior year. Most of my taxable income shows up in December, so I could do this (extra work) every year, but since I already set aside funds for taxes based on prior year taxes owed, I tend to pay them in even quarterly installments and wait to resolve any discrepancy until Jan of the next year.

Sounds like similar systems. My March and June instalments are based on tax paid two years prior while the Sept/Dec instalments are based on the previous year tax less already what's already paid in March/June. If you think your tax will be less in the current year you can install less but you better be right or you will incur penalties. I can easily forecast my taxes based on pension and dividends but if I sell/gift stock near year end if can have a big impact on current year's tax. For this reason I generally install what they ask for. Sometimes this results in large over installing and resulting tax refunds. I'm generally OK with this.

 

[audreyh1]

How do you treat the thousands of dollars of cash-back money from your credit card?

I have a cash rewards category in Quicken, and it shows up in my expense report as a negative expense.

Ours often exceed $2000.

 

[audreyh1]

Sounds like similar systems. My March and June instalments are based on tax paid two years prior while the Sept/Dec instalments are based on the previous year tax less already what's already paid in March/June. If you think your tax will be less in the current year you can install less but you better be right or you will incur penalties. I can easily forecast my taxes based on pension and dividends but if I sell/gift stock near year end if can have a big impact on current year's tax. For this reason I generally install what they ask for. Sometimes this results in large over installing and resulting tax refunds. I'm generally OK with this.

This is why I think the systems are different. In the US I can safely pay low estimated taxes and pay a big amount Jan 15, as long as I show when I file by April 15 that the bulk of my income was received in the 4th quarter. I have to file form 2210 to show how much income I received each quarter. But as long as the taxes paid for each quarter covers the income (annualized) received so far, there will be no penalty. Annualized means the income received YTD is converted to year income - first quarter multiplied by 4, for example - before calculating taxes owed, and then 22.5% of those taxes are due 2 weeks after the end of the first quarter.

So, have some big taxable events at the end of the year does not cause problems with paying estimated taxes for prior quarters.

 

[Danmar]

This is why I think the systems are different. In the US I can safely pay low estimated taxes and pay a big amount Jan 15, as long as I show when I file by April 15 that the bulk of my income was received in the 4th quarter. I have to file form 2210 to show how much income I received each quarter. But as long as the taxes paid for each quarter covers the income (annualized) received so far, there will be no penalty. Annualized means the income received YTD is converted to year income - first quarter multiplied by 4, for example - before calculating taxes owed, and then 22.5% of those taxes are due 2 weeks after the end of the first quarter.

So, have some big taxable events at the end of the year does not cause problems with paying estimated taxes for prior quarters.

Right. Systems are different. If I don't pay the right amounts quarterly, I will incur penalties. No way to catch up after the fact.

 

[Cobra9777]

How do you treat the thousands of dollars of cash-back money from your credit card?

Expense reduction. In effect, the cash-back reward reduces the cost of everything you buy with the card. In theory, one could allocate by category of expense according to the original expense profile that earned the cash-back reward. But I would be shocked if anyone actually does that. I put the credit in a "catch-all" category called Miscellaneous.

 

[Gotadimple]

How do you treat the thousands of dollars of cash-back money from your credit card?

As a reduction in overall expenses. I post it as a negative expense. It is, in fact, a rebate for using the credit card on the overall expenses.

For budgeting purposes, I don't expect to earn the rebates, so I can carve out the statement credits from overall charges - most of the time. But to LOL's original question, there are other rebates that are only valid at future purchases in store (i.e., grocery chains, REI, Costco). I don't account for those or budget to get them.

Budgeting is an inexact science. One can split the hair finely into several minute strands or go for the big picture. I prefer the bigger picture - I have retirement living as my top priority!

- Rita

 

[audreyh1]

Right. Systems are different. If I don't pay the right amounts quarterly, I will incur penalties. No way to catch up after the fact.

I'm glad we have a system that lets you pay as you go - it's not really catching up after the fact since you pay 2 weeks after each quarter end and taxes are only owed quarterly. So you simply pay what is owed "on time".

It's a complicated system and I had to build some clever spreadsheets, but way better, IMO than having to way overpay taxes because you can't predict current year income.