Tax Articles

Tell Clients Where to Stick Their Refunds

New Options for Habitual Refund Filers

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If you've told your clients once, you've told them a thousand times: Overpaying your taxes to get a tax refund at tax time is not a good idea. It amounts to giving Uncle Sam an interest-free loan. But clearly, the message is not getting through. Approximately three-quarters of the tax returns that the IRS processed last year resulted in refunds. And the average refund was more than $2,300.

Face it, people like tax refunds. Many will argue that a planned tax refund is a kind of forced savings. But is that refund really saved once the check has been cashed? In many cases, the answer is "No." After all, that big screen TV or luxury vacation can be pretty tempting once that check arrives. In fact, in a recent survey more than 40% of people said they planned to spend their refunds.

Starting next year, the IRS is offering a new option that may help your clients avoid temptation.

IRS Provides a New Option

For the 2010 filing season, taxpayers will be able to direct IRS to use their tax refunds to buy Series-I U.S. Savings Bonds in their own names (for married taxpayers filing jointly, in both spouses names). Beginning with the 2011 filing season, taxpayers will be able to use their refunds to buy Series-I bonds in their names and the name of a co-owner such as a child or grandchild.

The bond option is not an all-or-nothing proposition. A taxpayer can direct that only a portion of a refund be used to buy savings bonds and have the remainder issued as a refund check, directly deposited to a checking or savings account, or contributed to an IRA.

Savings bonds can be purchased through the refund option in denominations of $50, $100, $200, $500, and $1,000. If a taxpayer buys $250 or less of savings bonds with a tax refund, $50 Savings Bonds will be issued. If the amount is over $250, $50 Savings Bonds will be issued up to $250 and the fewest possible additional Savings Bonds will be issued for the remainder amount.

Example, Brenda is due a $2,500 federal income tax refund for 2009. She decides to save $1,000 of the refund by buying savings bonds, to save another $1,000 by having the IRS direct deposit that amount in her IRA, and have the IRS direct deposit the remaining $500 to her checking account. Brenda puts these instructions on her Form 1040 giving the IRS the routing and account numbers for her IRA account and checking account. Brenda will receive six $50 savings bonds, one $200 savings bond, and one $500 savings bond.

Logistics

Treasury will mail the bonds directly to taxpayers. The refund option won't require taxpayers to have previously set up an account with Treasury to buy bonds.

The savings bond option will be incorporated into the 2009 version of Form 8888, which is currently used to have a refund directly deposited into more than one account or IRA. Form 8888 will be filed with Form 1040 to direct that all or part of a refund be used to buy bonds and/or directly deposited in one or more accounts.

Aside from securing their tax refunds from temptation, the savings bond option may have other advantages for your clients. Savings Bond interest is subject to federal income tax; however, the tax can be deferred until redemption, final maturity, or other taxable disposition, whichever occurs first. Alternatively, clients have the option of reporting the interest annually for federal income tax purposes.

Education Option, up to a Point

In addition, clients may be able to exclude all or part of the interest earned to the extent the bond proceeds do not exceed qualified higher education expenses for the year of the redemption. This exclusion is reduced or eliminated for higher-income taxpayers. For example, for 2009 the tax exclusion begins to be reduced for single taxpayers with modified adjusted gross income of $69,950 or more, and is eliminated for singles with modified adjusted gross income of $84,950 and above. For married taxpayers filing jointly, the tax exclusion for 2009 is reduced when modified adjusted gross income reaches $104,900 or more and is eliminated when modified adjusted gross income reaches $134,900 or more. Married couples must file jointly to be eligible for the exclusion.

Savings bonds must be issued in the name of a taxpayer age 24 or older at the time of issuance to qualify for this tax break. And the bonds must be solely owned by the taxpayer or jointly owned with a spouse. Bonds purchased with a co-owner other than a spouse do not qualify. Consequently, clients who wish to take advantage of the exclusion should not elect to name another individual as co-owner when that option becomes available in 2011.

Reach Out to Clients

So you can reach out to clients who routinely receive a refund on their income taxes, we've prepared a brief introduction and invitation that you can print to letterhead or paste into an email to your clients.

The introduction is in the form of Microsoft Word document. Download to your computer to save and modify as appropriate.

1. Dear Client - Savings Bonds for Refunds (Word doc., 29 KB)

Terence M. Myers, J.D. and Dorinda D. DeScherer, J.D. are nationally renowned writers on tax topics for such publications as Accountants Tax Weekly, Tax Return Preparers Letter, Nonprofit Tax and Financial Strategies, and Executives Tax and Management Report. For many years Myers was Managing Editor and DeScherer Assistant Managing Editor for many Prentice Hall tax newsletters. Myers and DeScherer have published books and other publications with Harcourt Professional Publishing, Aspen Publishers, Prentice Hall, and the AICPA.

Last Updated: 10/06/2009