According to the IRS the average tax refund last year was over $2,500. I always encourage taxpayers to do something smart with this money, and it is never too early to begin planning for next tax season. If you use your refund in one of the following ten ways, then you can get a head start on lowering your 2010 tax liability.
1. Put the Funds into a Traditional IRA
When you file your tax return you have the option to have your refund split between up to three different accounts. You can even have funds electronically transferred to a tax friendly traditional IRA. You can use these contributions to lower your adjusted gross income for the year.
2. Purchase Inflation-Adjusted Savings Bonds
In addition to transferring funds to a retirement account, the IRS has recently began allowing taxpayers to use a portion of their refund to buy inflated adjusted saving bonds, commonly referred to as I Bonds. The government makes this process easy, all you have to do is fill out IRS Form 8888 and designate how much of your refund you want to invest in I Bonds. They are exempt from state and local taxes, and federal taxes are deferred until you redeem the bond.
3. Use the Money for a Down Payment on a House
We all know there are multiple tax advantages of homeownership. You can write off mortgage interest, deduct property taxes, and many homebuyers qualify for IRS credits of up to $8,000. If your refund is large enough, you could use it as a down payment on a house. If you do qualify for a new homebuyer credit then you can even use the funds to help cover your closing costs.
4. Make Energy Efficient Upgrades to your Home
If you already own your home then you might want to consider making energy efficient upgrades to your house. In addition to increasing the value of your property, many upgrades qualify for tax incentives. To find out the exact amounts, check out EnergyStar.gov.
5. Make a Donation to a Qualified Charity
You can easily donate a portion of your tax refund to a qualified charity to directly reduce your adjusted gross income. Even if you cannot afford to make a large monetary contribution all miles driven to, from and during volunteer work are deductible expenses, as well as any goods or supplies you purchased while volunteering.
6. Invest in Yourself
Instead of investing your money into a retirement account you could invest in yourself and take a class at a local university. Depending on your income level the American Opportunity Tax Credit could cover the cost of up to the first $2,500 in qualifying tuition and related expenses.
7. Buy a Qualifying Hybrid
Although popular cars such as the Toyota Prius no longer qualify for the Alternative Motor Vehicle Credit, there are plenty of vehicles that do—Including the Ford Fusion Hybrid, which qualifies for a $3,400 credit.
8. Open a 529 College Savings Fund
Contributing to a 529 College Savings Plan is another smart use for your IRS refund. Similarly to a Roth IRA, you do not have to pay taxes on the interest that accumulates in the account.
9. Buy New Office Computers or Equipment
If you are self-employed or own a small business then you can use your refund to purchase new office computers, furniture, equipment, or just about anything else that qualifies as a business expense. Just be sure to save all of your receipts!
10. Purchase a Health Insurance Plan
Those of you who are self-employed taxpayers can also take a deduction for your health insurance expenses. I recommend purchasing your plan now so that you can use your refund to pay for a majority of the yearly premium, which will lower your monthly payments.