Tax Savvy Prep: Demystifying Tax Terms and rethinking Your Tax Refund

It is no surprise to you that it's Tax Season, by now you have likely seen a tax form in the mail or downloadable for you to begin your process. You might not be thinking about filing your taxes until early April, but as a Financial Coach tax time is a great time to talk with people about their money choices. WHY because people are thinking about their money. Often, people think about tax time in terms of how their money is being spent in tax dollars and how to minimize their tax bill. I am not a CPA or an EA so I am not going to give you tax advice. I will explore some popular tax terms, make a plan for tax returns, and share resources to make your tax prep and filing less stressful.

Tax Terms to help you prep– Let’s break down popular tax terms and what they mean to you as an individual

o   Taxable income – Income that is taxable may be both earned and unearned income such as interest and dividends.  

o   Tax Deduction An amount either personal or business expense that reduces the income subject to tax. There are what are called Above the line and Below the line Deductions.

o   The line is – your Adjusted Gross income line. So those deductions taken above the line reduce your taxable income.

o   Tax Credit – can be refundable or nonrefundable and lower your taxes that are due

o   Refund – A refund is typically an overpayment of taxes.

o   Filing Status - Determines the rate at which income is taxed based on one of the five filing statuses which are single, married filing a joint return, married filing a separate return, head of household, and qualifying widow(er) with dependent child. However, you can’t just choose one you have to actually be in the status that you select.

o   Dependent - A qualifying child or qualifying relative, other than the taxpayer or spouse, who entitles the taxpayer to claim a dependency exemption. There are specific rules and guidelines that include but are not limited to must be a U.S. citizen, resident alien or national, or a resident of Canada or Mexico, a person can't be claimed as a dependent on more than one tax return, with a few exceptions

Employer Benefits that reduce taxable income.

In our terms above we defined what taxable income is but did you know that your employer may offer benefits that you can enroll in during your company's open season to reduce your taxable income? Not only could you take advantage of employer-provided benefits, but you could over time improve your financial situation by reducing your taxable income and possibly even lowering your tax bracket. If you have the option to opt into any of these benefits the income that pays these premiums or is set aside is considered pre-tax money. Pre-tax money is money that is utilized before taxes are determined from your income, so your gross income that is considered for taxes is reduced by these specific premium amounts. However, you need to make sure you understand the rules, conditions, and how you may or may not fully benefit from selecting these benefits. Let’s break down some of the benefits that you might be overlooking –

Health Savings Account (HSA)  – if you have a high deductible health plan, you may be eligible to utilize an HSA. This account allows you to put away pre-tax dollars into an account to be able to utilize for future medical expenses. These funds do not expire and can continue to grow.

Medical Flexible Spending Account (FSA) – This account allows you to save a certain amount of money per tax year and the funds are deposited pre-tax. You can utilize these funds on future medical needs within the plan or taxable year. These funds are use-it or lose-it funds and must be spent within the plan dates. It will be important to not overfund this account.

Dependent Care FSA - This account allows you to save a certain amount of money per tax year and the funds are deposited pre-tax. You can utilize these funds for childcare expenses which may include daycare, before and after-school care, summer camps, etc. These funds are also use-it or loose, so it will be important to pay attention to plan dates and total funding amounts.

Life Insurance – An employer-paid life insurance premium of up to $50,000 in coverage is excluded from your taxable wages. Any additional coverage over that threshold that is paid by your employer is going to be taxable wages. The amount of coverage that is nontaxable and offered by the employer may not be enough coverage but it may be a start as you build your financial wellness.

 Make a Plan for a Tax Refund

Now that you have a better understanding of tax terms and benefits let's talk about how to make a plan for your tax return that you might be receiving. If you received a tax return last year and you had no significant changes to your family and financial dynamic you are likely going to receive a tax refund this year. Two things to consider

1. How will you best utilize this financial opportunity?

2. Will you make any changes to your tax withholdings this calendar year to increase money in your monthly budget and reduce future overpayments of taxes?

Let's explore how to utilize your tax refund –

The best way to make a plan for you is to understand where your financial gaps are, your values, and how different choices will set you up for future success. If you have not taken stock in your financial choices, values, and goals now would be an opportune time to do so.

Below are a few different key categories that I think make great use of a tax refund these include debt, savings, and fun.

·      Debt

o   If you have any debt that is behind, I would suggest utilizing your refund to pay your bills current while also putting at a minimum half of your insurance deductible into savings.

o   Using a tax refund for paying off high-interest debt can be a great utilization, build a debt repayment plan and add a portion of your refund as a one-time payment. This will help you to determine which account would benefit from making a payment.

o   Making an additional principal-only payment to a mortgage or car loan can significantly decrease your future interest charges.

·       Savings

o   Tax refund time is a great time to begin, build, or boost your savings.  

o   If you have not started an emergency savings or you feel it is not fully funded, this is an opportune time to build or fill up that emergency savings.

o   Adding or beginning longer-term future savings such as personal retirement, spouse retirement accounts, or kids' education savings could be great utilizations for these funds.

o   Revolving savings if you have been thinking about creating a revolving savings account for purchases like vehicle maintenance, clothing maintenance, and replacement appliances these funds can be a great way to initiate that account.

o   Opening a high-yield savings account or Certificate of Deposit for future mid-term savings goals.

·       Enjoy

o   If you have checked in with your funds and are on track then maybe just have a little fun.

o  Take a night out on the town, buy those concert tickets you’ve been wanting to, or plan that vacation you haven’t taken!

At the end of the day, you want to ensure that these funds are going to work for you and build you up in your financial future. I always think that saving a portion of your refund purposefully is important if that’s 10% or 100% make it meaningful

Will you make a money change for tax prep next year?

Let’s tackle that second question I posed – Will you make any changes to your tax withholdings – This is a great question to explore with any partner that you share financial decision-making with, your tax professional, and/or the IRS.gov tax withholding calculator. Many times people look forward to a tax return because they have not adjusted their financial mindset to make savings a habit, so a refund becomes a protected savings account. If this resonates with you I encourage you to think about a refund differently.

The average American tax refund over the last 10 years has been $2891.70 over 12 months which is $240.98. I want you to think about what you could do with an extra $200 on average per month.

Would that allow you to reduce your debt, build breathing space in your budget, say Yes to a want, build your savings, and reduce the amount you spend on credit cards? As we talked about previously refunds are typically overpayments you receive no interest on these funds. Consider how adjusting your withholdings might benefit your budget and your planning.

As you prepare for tax season, staying organized and informed can make all the difference in reducing stress and maximizing your financial outcomes. Whether you're gathering receipts, reviewing withholdings, or strategizing how to use your refund, having a clear plan is essential. To help you get started and stay Savvy download my Tax Prep Checklist—your step-by-step guide to navigating tax season with confidence. It’s free, easy to use, and designed to keep you on track. Don’t wait—download it today and take the first step toward a smoother, more successful tax filing process!