What Is a Tax Refund? Definition and When to Expect It

What Is a Tax Refund?

The term "tax refund" refers to a reimbursement made to a taxpayer for any excess amount paid in taxes to the federal or state government. While taxpayers tend to look at a refund as a bonus or a stroke of luck, it often represents what is essentially an interest-free loan that the taxpayer made to the government. It’s often possible to avoid overpaying your taxes so you can keep more money in your pocket each paycheck—and avoid a refund when you file your tax return.

Understanding Tax Refunds

It can be exciting to get a large tax refund. You can expect to get a refund if you overpaid your taxes during the year. This generally happens when taxes are deducted from your paycheck every time you get paid by your employer.

Here are some reasons why a taxpayer might get a refund:

• The taxpayer made an error in filling out Form W-4, used to estimate the correct amount of withholding from the employee’s paycheck.
• The taxpayer intentionally fills out their W-4 to have a higher withholding and larger tax refund at tax time.
• The taxpayer forgot to update their W-4 to reflect a change of circumstances, such as the birth of a child and an additional child tax credit (CTC).
  
• A freelancer or self-employed person who files quarterly estimated taxes may overpay to avoid a surprise tax bill or underpayment penalties at tax time.
• The taxpayer is eligible for refundable tax credits, which can reduce the amount of taxes owed below $0. In other words, if the credit is larger than your tax bill, you will receive a refund for the difference.

Tax refunds are the opposite of a tax bill, which refers to taxes owed by a taxpayer. In the case of a tax bill, you owe more taxes to the government than you paid during the year. You normally have a tax bill if your employer doesn't withhold enough taxes from your paycheck.

Special Considerations

Taxpayers are generally better off not overpaying their taxes in the first place because that money could be put to better use. For example, you could adjust your withholding (or estimated quarterly taxes, if you’re self-employed) and invest that extra money in your individual retirement account (IRA), 401(k), or even an interest-yielding savings account. That way, the money is working for you instead of for the federal government.

Refundable Tax Credits

Most tax credits are nonrefundable, meaning that the tax credit can only reduce a taxpayer’s liability to $0. Any remaining amount from a nonrefundable tax credit is automatically forfeited by the taxpayer. For this reason, this type of tax credit is sometimes called a wastable tax credit.

In contrast, a refundable tax credit pays out in full, meaning that a taxpayer is entitled to the entire amount of the credit regardless of their income or tax liability. If the tax credit reduces the tax liability to below $0, then the taxpayer gets a refund.

Refundable tax credits include:

Child Tax Credit (CTC)

The child tax credit is $2,000 maximum for eligible taxpayers. The fully refundable portion is $1,600 for 2023 and $1,700 for 2024.

Earned Income Tax Credit (EITC)

The Earned Income Tax Credit (EITC) gives low- and moderate-income workers and families a tax break. The credit is $7,430 in 2023 and $7,830 in 2024. The amount of credit that a taxpayer receives depends on their income, filing status, and the number of children they have. For example, eligible taxpayers who have no children will receive $600 for tax year 2023. That figure increases to $632 for tax year 2024.

American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) is a partially refundable tax credit that is available to taxpayers to offset qualified higher education expenses (QHEEs). If a taxpayer reduces their tax liability to $0 before using the entire portion of the $2,500 tax deduction, then the remainder may be taken as a refundable credit up to the lesser of 40% of the remaining credit or $1,000.

Premium Tax Credit (PTC)

Low- and moderate-income households may qualify for the premium tax credit (PTC), which lowers the monthly premiums for health plans offered through the federal and state health benefit exchanges. Taxpayers can use all, some, or none of their PTC in advance (i.e., upfront). If taxpayers use less PTC than they qualify for, they will get the difference as a refundable credit at tax time.

How Tax Refund Are Issued

Tax refunds usually are issued either as checks and sent by U.S. mail or as direct deposits to the taxpayer’s bank account. Alternatively, taxpayers can use the refund to buy U.S. Series I Savings Bonds or have it loaded on a prepaid debit card. The fastest way to get a refund is to e-file your tax return and choose direct deposit.

Most refunds are issued within a few weeks of when the taxpayer files their tax return. However, there may be some instances where a refund takes longer.

For example, taxpayers who claim the EITC will receive their refunds by February 27. That's because the law requires the IRS to hold on to these refunds until March due to years of fraudulent filings for the credit.

Refunds are always pleasant, but it would be better to avoid overpaying in the first place by correctly filling out your W-4 or precisely calculating your estimated taxes. The closer you get your refund to zero, the more money you will have throughout the prior year.

Of course, not everyone agrees. Some people consider tax refunds an alternative savings plan and look forward to the lump-sum repayment.

The Bottom Line

A tax refund is an amount of money that the government reimburses taxpayers who pay more than they owe in taxes. In general, it's a good idea to calculate the taxes that you'll owe as precisely as possible so that you don't overpay throughout the year. That way you can keep more of your money and put it to work for your best interests, whether that's earning a return and building your savings or paying off debt.