Thursday, January 3, 2013

Direct deposit of your tax refund can go awry

Ever since Congress passed the Pension Protection Act of 2006, you've had the option of depositing your income tax refund directly to an individual retirement account or IRA. In theory, that sounds like a good thing. Like paycheck contributions to a 401(k) account, depositing tax refunds directly to an IRA ensures that they're "out of sight and out of mind." You don't receive a check in the mail, and the refund doesn't show up in your checking account. So you're less likely to spend it on tires for the car or a vacation in Mexico.
Instructing the IRS to deposit your refund to an IRA is accomplished by filling out a one-page form (Form 8888). By attaching this form to your tax return, you can split your refund and have it deposited to as many as three separate accounts. (Direct deposit to only one account can be designated directly on your tax return.) The IRS touts four advantages to direct deposit: faster refunds, more secure payments, convenience (you don't have to make a trip to the bank), and less cost for the government.
But the process can go awry in at least three ways:
  • Wrong year. Let's say you want your tax refund designated as an IRA contribution for 2012. If the custodian of the IRA doesn't get that message and applies the refund to 2013, you may have problems. In fact, the mistake may affect your tax liability for both years. For 2012, you may owe more taxes because contributions aren't credited against your income; for 2013, your contributions may exceed IRS limits, resulting in penalties. So it's crucial that the custodian of your retirement account knows your intentions.
  • Wrong account information. Transposing routing or account numbers, or mistyping even a single digit may result in major headaches. At the least, your refund may be held up. At the worst, your money could end up in someone else's account. Also, if the wrong account type is designated, your bank may not accept a direct deposit.
  • Wrong refund amount. Math errors happen. If you miscalculate the tax refund, or if the total of the amount to be allocated doesn't agree with the total refund claimed, the IRS will likely send a check for the corrected

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