Why a Big Tax Refund Is a Bad Sign

If your withholding is off, you're making Uncle Sam an interest-free loan.

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Getting a check from the IRS is better than writing one, but accountant Andrew Schwartz's more sophisticated clients understand that a sizable refund every year can be deceptively pleasing. That's money that could have been in their pocket sooner.

Schwartz, of Woburn, Mass., says he has to walk a fine line: "We can easily jeopardize our relationship with clients if when their return is done they either owe a large amount of tax or they get a big refund."

Here's a look at strategies to walk the tax line successfully:

Balancing act. Keeping control of the tax you pay through the year via withholding and possible quarterly estimated payments is more challenging the more variable or unpredictable your income.

"If the tax you pay in is too little you can be hit with a penalty," cautions Bob Scharin, a senior tax analyst at Thomson Tax & Accounting, a provider of tax information and software. "If you send in too much, you cheat yourself."

Investment gains and losses, irregular self-employment earnings, a big taxable withdrawal from a retirement account, and other complications can require deft maneuvering.

Withholding can occur all year. Estimated payments—often required when withholding won't do the job or income isn't subject to it—are generally made quarterly. The first payment for 2008 income is due this April 15.

False promise. A tax preparer can keep you happy with big refunds by having you pay too much tax upfront—making an interest-free loan to Uncle Sam until you file your return. A better preparer will suggest ways to stay closer to what's required.

Reality check: Many people fear owing anything and see a refund as a spring treat. So it's often best to err on the side of paying in a bit too much.

Help. Guidance is available from IRS Publication 505 ("Tax Withholding and Estimated Tax") and Publication 919 ("How Do I Adjust My Tax Withholding"). Both are at irs.gov online.

Form 1040ES for making estimated payments has a worksheet, as does form W-4, which you give to your employer to determine withholding from paychecks.

A withholding calculator is online at the IRS website.

Less withholding. Having a child, buying a home, paying college bills, opening an IRA, and boosting charitable donations are among the events that can trigger bigger deductions and credits and may require a new W-4 to lower withholding.

It may be small comfort, but a jump in interest on an adjustable-rate mortgage can mean a bigger tax deduction and thus less tax owed, notes analyst Scharin.

More withholding. Events that can require greater withholding or estimated payments include taking money out of a tax-deferred savings or retirement plan, cashing in investment gains, moving into a rental apartment, and losing a dependent who becomes self-supporting.

More...or...less. Changes that can necessitate a review to either raise or lower interim tax payments include getting married or divorced, retiring, moving to a new state with different deductible local taxes, and having a spouse who quits or returns to work.