It’s that time of year again. That time when Uncle Sam returns some of your hard-earned tax dollars that he’s been borrowing at zero-percent interest. Tax refunds are sort of a forced savings account for many people. And while I personally aim to avoid receiving a tax refund, there are some smart things to do with one once you receive it.

Kimberly Lankford, contributing editor at Kiplinger’s Personal Finance magazine, put together five smart uses for your tax refund. I’ve expanded on her ideas, and added eleven of my own to the list below.

Smart Things to Do With a Tax Refund

1. Pay off high-interest credit-card debt. Kimberly listed this one first, and for good reason. Eliminating credit card debt is one of the smartest ways to spend any windfall. The higher the interest rate on your debt, the bigger the payoff. Think about it; where else can you get a guaranteed return of 22% on your money?
2. Rebuild your emergency fund. Thanks to unemployment, underwater mortgages, and a general economic funk, many households have had to turn to emergency funds to weather the storm. It makes sense to allocate some or all of your tax refund towards covering future emergencies.
3. Boost your retirement savings. If your debts are paid, and you have plenty of money saved for emergencies, the next biggest bang for your refund buck is to invest in your retirement. Maybe that means funding a Roth IRA, if you are eligible. If not, drop the money in a savings account, increase contributions from your paycheck to your 401k plan, and use the savings to offset the difference.
4. Build your college savings. It’s tough to carve out retirement savings, college savings, and put a roof over your family’s head and food on the table. After all, there are only so many dollars to go around. Boost your kids’ college savings by opening a 529 college savings plan (here’s a look at the best 529 plans).
5. Help your kid save for the future. If you are the parent of a teenager that earns an income, did you know you can help them open a Roth IRA? No kidding. The only requirement is that your teen files a tax return. He or she can invest in a Roth IRA up to their earnings, or the maximum yearly contribution, whichever is smaller. So, if your daughter earned $1,800 last year babysitting, kept meticulous records and files a return, you could gift her $1,800 to invest in a Roth IRA. She’ll be well on her way to becoming a millionaire.
6. Start a side hustle. Ah, the infamous side hustle. Many of the world’s most successful entrepreneurial efforts were started on less than $1,000 (I started Frugal Dad on less than $50!). Use your tax refund to seed a business you’ve always dreamed of running.
7. Invest in a home improvement project. Lean towards projects that improve your home’s efficiency long term. For instance, installing a programmable thermostat and planting a few trees around your property will go a long way towards reducing your future monthly energy costs.
8. Open a “Car Replacement Fund.” Let’s face it; the car you are driving now will eventually die. Why not divert a little tax refund money to start a car replacement fund. If your current car is paid for, save what amounts to be a car payment in this account and when the time comes you can pay cash for your next car.
9. Build a square foot garden. Use a couple hundred dollars of your tax refund to purchase gardening supplies, soil, and seeds. Now’s a great time to plant, and soon you’ll be enjoying tomatoes right off the vine, instead of those shipped across the country in your grocer’s produce section.
10. Give it away. If you’ve been considering giving money to a charity, now is a great time. Donating your tax refund to a worthy cause can even help on next year’s taxes, as most charitable contributions are tax deductible.
11. Pay extra on your mortgage balance. We personally plan to pay off our mortgage early. Why? Because we value the freedom a debt-free lifestyle affords. Sure, we’ll miss a tax break or two, but I’d gladly end sending $14k to my mortgage company each year to save $3k on my taxes.
12. Get your will done. My wife and I recently updated our wills after a death in the family. Identifying guardians for your children, and disposition of your stuff in the event of your death is not fun, but it is absolutely necessary. If you have kids and do not have a will, stop everything, financially, until you have enough saved to visit an attorney and have one drawn up. It is that important.
13. Purchase a gym membership. Many gyms offer significant breaks for those that opt to pay one year in advance. My gym offered two free months and waived the registration fee if I agreed to pay for the full year, effectively shaving $90 off my annual gym costs. Be sure to check out the gym’s refund/cancellation policy before agreeing to such a long commitment.
14. Take a class. It doesn’t have to be an academic class, but it could be. Maybe you’d like to learn more about cooking, or self-defense, or real estate. Investing a little tax refund money in yourself can go a long way.
15. Go on a “paid-for” vacation. My family recently enjoyed our first cash vacation, and it was awesome! I didn’t have any bills to dread on the ride back home.
16. Create your own “car insurance savings account.” If you currently have a $250 or $500 deductible on your car insurance policy, consider raising it to $1,000 and parking $1,000 of your tax refund in a dedicated savings account. You’ll enjoy a permanent way to save money on car insurance premiums, and earn a little interest on your savings account.

If you’d like to avoid getting a large tax refund next spring, and instead get a boost to your take home pay now, check out the withholding tool at Kiplinger.com.

I’m willing to bet that if you turned on CNBC, CNN or MSNBC right now, within 10 minutes you would hear someone talk about how taxpayer money is being wasted.  Well in order to understand if it’s being wasted you would first have to know where your money is supposed to be going, then decide whether or not the venture in question is worth the change of course.  Most Americans would be able to tell you that tax money pays for schools and roads and protection, but do you know just how much of your tax money goes to these liberties?

Assuming that an American pays $100 in federal taxes a week, which are directly drawn from their paycheck, this is how the government would spend each and every one of those dollars.

• INCOME SECURITIES – $22.00

The biggest chunk of taxes is spent on a category called “Income Securities”.  While it sounds somewhat exotic, the majority of this category can be broken down into four well-known sub-categories.

1. Social Security ($11.50) – Hopefully, I will be able to cash in on social security when I become of age but there are no guarantees.  At $11.50, it’s the second largest tax expense today.
2. Welfare ($4.60) – Welfare is a taxpayer-funded program that provides assistance to taxpayers that can no longer support themselves.  A heavily abused program.  Roughly 5 million Americans receive welfare checks on a regular basis.
3. Disability ($3.50) – Disability is a government program that assists those who are physically or mentally disabled and are unable to earn enough money to support themselves.
4. Unemployment Insurance ($1.70) – With the unemployment rate as high as it’s ever been, unemployment insurance goes to fund just that, unemployment.  When the unemployment rate rises, so rises the percentage of your taxes that goes toward this service.

• MEDICAL – $20.30

No offense to the older population, but you guys are just gobbling up the tax money, aren’t you?  Medicare is the main component of this category, which provides discounted care for anyone over the age of 65 or usually anyone with a disability.  Another service provided under this heading would be Medicaid, which provides healthcare to low and no income families.

• COUNTRY AND NEIGHBORHOOD DEFENSE – $20.00

A close third, the defense of the county is a heavy taxpayer bill.  If the country is not fighting or preparing to fight a war, you can expect this amount to be lower, but right now, the breakdown within defense is as follows:

1. National Defense ($13.20) – As you can expect, the bill for national defense is the largest tax expense paid by the American public today.
2. Police ($2.70) – Not as much money as you think would go to the nations police officers, but one of the most important and overlooked portions of your tax dollars at work.
3. Prisons ($1.80) – Sadly, this number continues to increase each and every year as most prisons are grossly overpopulated.  The tax dollars going toward prisons may surpass the ones going to police officers very soon.
4. Courts ($1.20) – Public defenders, judges, prosecutors and other legal occupations are classified under the courts category.
5. Firefighters ($0.80) – Firefighters deserve twenty times this much, but for now they are on the low end of the tax totem pole.

• EDUCATION – $15.80

Only ~16% of taxes are put toward education, and when budgets needs to be trimmed, the first place most politicians look is toward the education system.  There are two major components of education and one secondary component.

1. Elementary and Secondary Schools ($11.70) – Grammar schools, elementary schools and high schools take up most of the funds.  Amazing that with that much money put toward education, there are still as many problems as there are.
2. Public College ($2.80) – State Universities receive this portion of your taxes which helps reduce the annual cost of attending a public university.
3. Libraries ($0.70) – With the Internet as popular as ever, public libraries continue to be shut down across the country.

• RUNNING THE GOVERNMENT – $14.30

You didn’t think all of those politicians worked for free did you?  Running the US government carries a hefty tax price tag.

1. Borrowed Money ($9.00) – Because taxes never foot the entire government budget, borrowed money means interest payments.  Seems like such a waste of money to have 9% of our taxes pay for nothing more than interest.
2. Legislative and Executive Branches ($2.10) – The President of the United States certainly makes a very meager salary, but when you consider all of the politicians in Washington, it adds up fast.
3. Collecting Taxes ($1.10) – The main component here would be the IRS.  Weird to collect taxes that pay to collect taxes.  Defeats the purpose a little bit.

• MISCELLANEOUS EXPENSES – $7.60

With the major areas already taken care of, there are still a few decent size tax programs that do not fall into one of the above categories.

1. Roads ($2.50) – The government should probably set up a pot-hole tax program as well, because it seems every time I move, I find bigger and deeper potholes in the roads close to my home.
2. Air and Water ($0.70) – The purification of air and water has become big business over the last 20+ years and the government is always looking for ways to keep things even cleaner.
3. Public Parks ($0.70) – Conserving what’s left of the great outdoors is a high priority in my opinion, and I hope when I finally get around to traveling, all of the major parks are still around.
4. Space Program ($0.30) – Every time NASA sends up a new $20 billion satellite, give yourself a pat on the back.

So there you have it.  The next time you pay your end of the year taxes or think that Uncle Sam is screwing you, you know exactly where your money is going.  The realization is that most of the above programs are very necessary to keep the US of A growing, and it’s really hard to dispute any of them.

Dan writes in with the following question regarding tax refunds and withholding:

I am a married sailor with two kids. I still have taxes taken out as though I were a single man. The reason I do this is because I lack the discipline to handle the extra money each pay check. It’s kind of nice to overpay every year and get the lump sum back from the government. Then my wife and I pay down some of our debt and move on. We don’t splurge with this money.

I’ve been told many times that I’m just giving the government an interest-free loan and that I should pay more down on my debt each month instead of once a year, but I’d like to get your thoughts on this.

There have been many debates about the practice of withholding too much in taxes to receive a large refund at the end of the year. I tend to agree with others who have advised that this is sort of like allowing the government to use your money, tax free, throughout the year and then return it to you at the end of the year.

A better way to think about it is to examine the opportunity costs associated with getting a large refund. Let’s assume your tax refund last year was $6,000. That works out to about $500 a month too much in taxes withheld from your pay.

If you dropped that $500 a month in an online savings account averaging a 3% yield, you’d have $6,100 after the first year. That’s $100 you’re missing out on each year just by having the government hold your money. But that’s not all.

If you used some or all of that money to pay down debt throughout the year, instead of waiting until the end of the year, you would likely pay less in interest charges, too.

There is also the issue of security. You didn’t mention an emergency fund in the mix, but this $500 a month would go a long way towards building a buffer between your family and the next financial emergency. If that same money is tied up in taxes, you won’t see it until February, and it won’t be available to help cover those inevitable expenses all households experience.

Having said all of that, I can appreciate the idea of using taxes as sort of a “forced” savings account. Often times we have to use things like this to protect ourselves from ourselves. If you will likely blow the $500 a month instead of socking it away, or using it to pay down debt, then over-paying taxes throughout the year and counting on a big refund might make sense. Still, I’d look for a way for you to control that money yourself and get some benefit from it.

I use TurboTax to complete my personal and business taxes.

I made the mistake yesterday of sharing a link with Twitter followers indicating the Cash for Clunker rebate would be treated as taxable income. Astute followers quickly pointed out that the link I shared was from a site spreading a false rumor about the Cash for Clunkers tax implications for buyers.

Instead, I should have checked out the C.A.R.S. government-run site, which provides the following answer to the burning cash for clunker tax rules question:

Is the credit subject to being taxed as income to the consumers that participate in the program?

NO. The CARS Act expressly provides that the credit is not income for the consumer.

While I wasn’t fond of the Cash for Clunkers program from the get-go, I concede that it spurred on many more sales than I expected. In fact, it might be the first program with any real stimulative effect since the passage of over a trillion dollars in bailouts and stimulus packages.

It seems Americans are always up for a $4,500 rebate. However, the suspicious consumer in me wondered if the manufacturers suggested retail price (and dealer price) didn’t go up in advance of the deal. After all, an increase in consumer buying power, especially when generated artificially as in the case of a government rebate, is often followed by higher prices.

I also wondered if consumers would be trading in cars for a rebate when they could have received much more money via a private sale. But that is always a risk when trading in a car at a dealership. The dealer is not going to give you top dollar because he has to leave a little room to make that when he resells the car (not a problem under Cash for Clunkers since they were ordered to be destroyed) he turns a small profit, or at a minimum breaks even.

Debt is also a concern. How many people trade in a paid-for clunker for a shiny new car with a big auto loan? It might be better for the environment, but is it better for your family finances? That remains to be seen. Might be a good time to be in the repo business, though.

All this is water under the bridge now, as the Cash for Clunker program ended Monday night. However, it sure would have been quite the surprise to learn Cash for Clunker tax rules meant the rebate you received was treated as taxable income. From my web research, it sounds like there still may be an issue for dealers, and even buyers may not be completely out of the woods when it comes to state taxes on Cash for Clunkers. At least it appears Cash for Clunkers will not negatively impact buyer’s federal taxes.

Additional Resources:

• Cash For Clunker Payments – Tax Rules
• Cash for Clunkers Tax Rules – The Truth
• (More) Cash for Clunkers Tax Rules
• Does Cash for Clunkers Affect Your Taxes?
• Tax Rules And Consequences Of The Cash For Clunkers Program

With April 15th fast approaching, and a couple things lining the calendar for the next couple weekends, I thought I would bite the bullet, fire up TurboTax, and finalize my 2008 taxes.  Besides, the weather was dreary out and there wasn’t much else to do.  I ran through estimates earlier in the year, and thanks to a bit of self employment income, had already ruled out the chance of receiving a tax refund.  So I set things aside determined to revisit them in time to meet the tax filing deadline.  I learned a few painful lessons.

Self Employment Tax

Tax year 2008 was the first year I had any self employment income to speak of.  It was also my first introduction to the self employment tax.  When you work for an employer, you split the tax rate for social security and Medicare.  But when you are in business for yourself you pay both sides of the equation – 15.3% (12.4% for social security and 2.9% for Medicare).  It may not seem like much, but the self employment tax rate paid on top of your normal income tax rate can make for a large tax liability.

Estimated Tax Payments

Speaking of large tax liabilities, if you plan to have to pay more than $1,000 or so in self employment taxes, it is a good idea to make estimated tax payments on a quarterly basis to avoid underpayment penalties.  Think of this as you withholding from your own income, similar to the way companies withhold tax payments from an employee’s paycheck.

Estimated tax payments may be made free online using the EFTPS (Electronic Federal Tax Payment System).  Once your enroll at the site you are mailed a PIN to the address on record with the IRS.  The pin takes a couple weeks to arrive, so plan accordingly.  Once you have the PIN you may create an online profile/password at EFTPS and you are on your way.

To simplify things a bit, I set aside 30% of my self employment income (freelance writing, ad sales, etc.) in a sinking fund at one of our designated online banks.  When the time comes to make quarterly estimates, I simply transfer money from my “Taxes” sinking fund using the EFTPS.

*Note, 30% may be too high or too low for your specific situation.  It’s a good idea to review last year’s taxes and determine your tax liability for self employment income to come up with a starting amount due for this year.  Be sure to increase or decrease that amount based on your revenues.

Improve Your Record-Keeping System

A good record-keeping system is vital to the success of any entrepreneurial venture.  After all, without tracking profits and losses, how do you even know if what you are doing is worth the effort?  It is also a big help around tax season.  Even if all you do is create a file folder labeled “2009 Taxes” and toss all receipts and income statements there, it’s a start.

Those of us with self employment income have legitimate opportunities to deduct expenses from our income.  For instance, as a blogger I can deduct things like hosting fees, domain registration and renewal costs, graphic design fees, etc.  This is a short list of the many potential tax deductions for bloggers.  Use only those that apply to you, and be sure to keep up with your receipts throughout the year to prove the expenses were paid.

Consider Hiring a Professional

Don’t take my word for it, consider consulting a tax professional, particularly when things get complicated.  A CPA, or someone specializing in taxes for small businesses, will help guide you through filing the appropriate forms, help determine which expenses are deductible from your income, and help you avoid any potential audit red flags.  I am a do-it-yourselfer by nature, but readily admit I will pay for tax advice when necessary.  Considering the consequences of an audit, penalties, etc, it might be the most frugal thing you could do.

Since originally writing this post I picked up a copy of Quicken Home and Business to manage my business finances. It’s been a life saver!

The following guest post is from Trisha Wagner.  Trisha is a freelance writer for DepositAccounts.com, where you can compare rates from dozens of banks in one place.  She writes regularly on the topics of personal finance and saving money.

It happens every year when tax time rolls around people scramble to find ways to make filing their taxes easier and limit the damage to their wallets.  What many people forget is by the time you file your taxes there isn’t anything you can do to change last years information, however you CAN take note and make changes now that will help you save money a year from now.  The following basic tips can help you make the changes needed today and at the end of the upcoming year to take the bite out of your next tax bill.

• Deductions- Are you claiming all the deductions that you are entitled to?  Many people mistakenly claim the standard deductions without fully investigating what they specifically may qualify for in their personal situation.
• Keep track of all business relates expenses and receipts- If applicable track all expenses related to a home business.  Get into the habit of doing this systematically, weekly or monthly to ensure you don’t lose receipts or track of what you spent your money on as time goes by.
• Remember donations to charity- Ideally you should be donating to charities that have a personal meaning to you with the added bonus of being about to lower your taxable income at the end of the year.  Remember to keep receipts for charitable donations.
• Take all applicable tax credits- Are you getting all the tax credits you are eligible for? If you have children under the age of 17 you may qualify for a $1,000 tax credit.  There are other tax credits for various things such as adopting a child, buying your first home, earned income tax credits, saver’s tax credit, child and dependent care credit and education-related credits.
• Tax-free investments- If you are looking for a tax friendly investment you might consider tax-free municipal or government bonds or other similar investments.  The returns are not as high as other investments but can be good for a high-income individual.
• Tax-free gifting- If you are have significant assets you may give up to $12,000 away tax-free for each individual you choose.  Typically this works well for retirees who may want to gift money now instead of bequeathing it to someone in their estate.
• Review Tax Returns- Specifically Form 1040 for missed tax opportunities from the previous year.  You should pay special attention to the Taxable Interest, Tax-Exempt Income, and Dividend Income lines.  Your tax bracket has critical affects on the effective yield of your investments.
• Check your work twice- Taxpayers could save millions of dollars each year if they took the time to double-check their work.  Error in tax preparation and on tax returns can be very costly for taxpayers.

It is important to remember that your financial situation, the economy and the tax laws change from year to year so it is important to keep up to date on tax information to ensure you are covering the basics each year and filing your taxes in a way that benefits you the most.

In the next week or so taxpayers should start seeing notices from the IRS in their mailbox. IRS notices have a tendency to cause panic in the hearts of their recipients, but not to worry. The notices are simply a “friendly reminder” from the IRS that this year’s economic stimulus payment eligibility is based on your 2007 tax filing. Those of you who delay filing for the 2007 tax year will likely see a delay in the first round of rebate checks, which should start rolling out in May.

The subject of what to do with these tax rebates has been written about in the personal finance community ad nauseam. So instead of piling on, I thought I would share what we plan to do with our tax rebate. According to most estimates we should receive $1,800 – $600 for me and my wife, and $300 for each child. Initially, I planned to use the entire $1,800 to pay down debt, but things have changed over the last couple months.

I desperately needed new tires on my old beater because steel thread was showing through and a blow out was probably imminent. Our emergency fund took a hit after finding the truck also needed new ball bearings and an idler arm. We’ll use the first $600 to replenish the emergency fund from the cost of repairs, labor and new tires.

My wife has been diagnosed with a problem with her knees, and I’ve got a bad ankle. Both our doctors have recommended a stationary bike to rehab our knees/ankle, respectively, and as a strategy for me to drop some weight. Jogging, and even long-distance walking, is out because I can’t take the pavement pounding. We’re currently looking at picking up a used recumbent bike in good condition from Craigslist or local advertisement. Prices vary, but we’ve set aside a couple hundred dollars from our refund for this purpose.

With the remaining $1,000 or so we plan to beef up our emergency fund and pay down debt. We plan a 50/50 split, putting $500 towards both efforts. I’ve always thought the $1,000 baby emergency fund suggested by Dave Ramsey was a bit anemic, considering larger repairs or replacement appliances can easily top that amount. Bumping up to $1,500 makes me feel a bit more comfortable and motivates me to really stretch to make large debt payments each month.

Have you locked down your plans for the tax rebate?