Every year I get a refund and the tax software asks me if I'd like to apply some of my refund to next year's taxes. Is there some benefit I'm not seeing to this? Because it looks like a bad deal to me.
Aside from the fear that you or a loved one will spend it frivolously, I'm hard pressed to come up with another reason. If you'll owe money in the next tax year, you have the rest of the year to adjust your withholdings and/or make quarterly payments. As both my fellow PFers state, you're better off getting your money back. Better still, use it to pay off a high interest debt.
There actually are legitimate reasons, but they don't apply to most people. Here are a few that I know of:
You're self-employed and have to pay quarterly estimated taxes. Rather than wait for the refund when you already have to pay 1/4 of next year's taxes at the same time, you just have the IRS apply to refund forward. (so you're not out the money you owe while waiting for your refund).
You're filing an amended or late return, and so you're already into the next year, and have a similar situation as #1, where your next year's taxes have already come due.
You're planning on declaring bankruptcy, and you're under the Tenth Circuit, those credits might be safe from creditors
For almost any other situation, you're better off taking the money, and using it to pay down debt, or put it somewhere to make interest (although, at the current rates, that might not be very much).
If you have non-salary income, you might be required to file 1040ES estimated tax for the next year on a quarterly basis. You can instead pay some or all in advance from your previous year's refund.
In theory, you lose the interest you might have made by holding that money for a few months. In practice it might be worth it to avoid needing to send forms and checks every quarter.
For instance if you had a $1000 estimated tax requirement and the alternative was to get 1% taxable savings account interest for six months, you'd make about $3 from holding it for the year. I would choose to just pay in advance.
If you had a very large estimation, or you could pay off a high-rate debt and get a different effective rate of return, the tradeoff may be different.
The refund may offset your liability for the next year, especially if you are a Schedule "C" filer. By having your refund applied to the coming year's taxes you are building a 'protection' against a potentially high liability if you were planning to sell a building that was a commercial building and would have Capital Gains. Or you sold stock at a profit that would also put you in the Capital Gain area. You won a large sum in a lottery, the refund could cushion a bit of the tax.
In short, if you think you will have a tax liability in the current year then on the tax return you are filing for the year that just past, it may be to your benefit to apply the refund.
If you owe money from a prior year, the refund will not be sent to you so you will not be able to roll it forward.
One specific example is you did qualify in the prior year for the ACA. If in the year you are currently in- before you file your taxes-- you realize that you will have to pay at the end of the current year, then assigning your refund will pay part or all of the liability.
Keep in mind that the 'tax' imposed due to ACA is only collected from your refunds. If you keep having a liability to pay or have no refunds due to you, the liability is not collected from you.
besides simple convenience, the only compelling scenario i can imagine is if you:
- file for an extension to file until october 15th for your year 1 tax return
- overpay before the april deadline for year 1 tax return
- underpay your q1 or q2 estimated tax payment for year 2
- apply your refund from your october filing retroactively to your q1 estimated tax payment thereby mitigating your underpayment penalty for q1 or q2.
even this scenario is relatively far-fetched. it's reasonable to overpay in year 1 because you're not sure exactly what your taxes due will be when you file, but it seems unlikely that you would subsequently underpay in year 2. that generally only happens if you have a large amount of income in q1, then try to spread the tax payments over 4 quarters, but then realize a large unexpected income in q2-4. it's a fairly rare scenario, which requires the taxpayer to lose several different calculated risks in a particular sequence.