Received an Unexpected IRS Refund? Here’s What It Means and What to Do

Tax Day is coming on April 15, 2025 and yours might be one of the 62% of returns that ends up getting a tax refund. There are smart ways to use that money to invest in both your short- and long-term financial health if you get an unexpected refund,

Key Takeaways

• A tax refund is a reimbursement from the government when you’ve paid too much in taxes during the year.
• Tax refunds can happen if you fill out your W-4 incorrectly, overpay your estimated taxes, are eligible for a refundable tax credit, or receive the Recovery Rebate Credit in 2025.
• You can use an unexpected tax refund to pay down debt, save for emergencies or college, invest for retirement, and even splurge a little.
• Tax audits can also surprisingly result in refunds.

What Is a Tax Refund?

A tax refund happens when you’ve paid too much in taxes so the government sends you a reimbursement. This can happen with state or local taxes but the largest refunds come from the federal government. The average federal tax refund was $2,948 in April 2024.

Some taxpayers may know that they’re likely to receive a refund. A freelancer who pays estimated taxes may overpay each quarter to avoid an unexpected tax bill due to the possibility of higher-than-average income at the end of the year.

Other taxpayers may not know they’re going to receive a refund until they finish preparing their tax return and realize that the IRS is sending them some money.

Important

You can check the status of your payment with the Where’s My Refund? tool on the IRS website if you expect to receive a tax refund,

Reasons You Could Get a Tax Refund

You might end up with an unexpected tax refund for several reasons.

Form W-4

Tax form W-4 is used to estimate how much income tax your employer should withhold from your paychecks and send to the Internal Revenue Service on your behalf. Your employer might have withheld too much all year if you didn’t complete the form correctly and you’d be entitled to get some of that money back.

You also might get an unexpected tax refund if you didn’t update your W-4 when you were supposed to. Your withholding rate should change if you had a major life change such as having a new baby, You’re probably having too much withheld from your paycheck if you didn’t update your W-4 with your employer after this kind of change.

Estimated Tax Payments

Many self-employed workers or freelancers make high estimated tax payments throughout the year to avoid a surprise tax bill in April. You’ll likely be entitled to a refund at tax time if you overpaid your estimated taxes throughout the year, especially if you didn’t account for business expenses when making estimated payments.

Tax Credits

A refundable or partially refundable tax credit such as the Earned Income Tax Credit (EITC) or the Additional Child Tax Credit can result in a tax refund. Most tax credits only reduce the amount of tax you owe down to $0 and the government keeps any amount that’s left over. Refundable credits can be sent to you as a tax refund, however, if they’re greater than the amount of tax you would otherwise owe.

Recovery Rebate Credit

The Internal Revenue Service announced in 2024 that taxpayers who were eligible for stimulus payments in 2021 but who didn’t claim the Recovery Rebate Credit will receive those payments in 2024 and 2025. The payment will be sent directly to you if you filed your 2021 tax return but didn’t claim the credit. You can claim it when you file your 2024 tax return in April 2025 and you’ll receive the credit as part of your tax refund if you didn’t file taxes in 2021.

Being Audited

Another surprising reason you might get a tax refund is that you’ve been audited. “We actually are able to correct people’s accounts all the time,” says Alyssa Maloof Whatley, a tax attorney who specializes in disputes with the IRS. “It’s not like every audit will end in someone owing money.”

Taxpayers often think of an audit as the government trying to collect additional taxes, but Whatley explains that the most common cause is a computer program flagging something in their tax return that doesn’t match other information the government has on file. This can result in an unexpected refund in some cases.

What to Do With a Tax Refund

Your first instinct might be to simply increase your spending that month if you get an unexpected tax refund or use it for a splurge you couldn’t otherwise afford. “Don’t just go to, ‘Oh I’ve always wanted to go on this trip,'” advises Melissa Joy, CFP, CDFA, and president of Pearl Planning. She tells her clients to think carefully about where that money should go instead. “Ask yourself where you can alleviate pain or increase safety.”

Pay Off High-interest Debt

“On the debt side, it starts with the interest rates,” says Joy. High-interest debt like credit card debt, personal loans that have a high interest rate, or a home equity line of credit can feel impossible to get on top of because the interest payments add up quickly.

It can help you eliminate a large part of that debt or even all of it if you suddenly have money from a tax refund. “Pay off things that should be short-term debt but have turned into medium or long-term baggage,” says Joy. “You’ll feel less burdened right away.”

Build Up Your Emergency Reserves

Consider using your tax refund to create an emergency fund if you don’t have high-interest debt to pay off. This kind of reserve can help prevent you from taking on high-interest debt in the first place when something unexpected happens. Even a small emergency fund can save you from having to put a surprise expense like a car repair or a broken refrigerator on a credit card.

“People can be afraid to use their emergency fund but that’s what it’s there for,” Joy points out. “Things are always going bump in the night so having an emergency reserve can really save you from having to tap into that high-interest debt.”

Save for Retirement

The next thing to tackle is saving for retirement if you’re not carrying high-interest debt and you have something saved for an emergency. Opening a retirement savings account can come with tax advantages as well as contribute to your future financial health.

You can open a Roth IRA or a traditional IRA regardless of whether you have another retirement account through your employer. A Roth IRA is funded with after-tax dollars so you don’t have to pay taxes on withdrawals in retirement. A traditional IRA lowers your tax bill now. The total contribution for any kind of IRA in 2025 is $7,000.

You can open an IRA through brokerage accounts and banks.

Avoid Student Debt

Paying off long-term debt can weigh down your financial life even if you aren’t paying high interest rates. A large chunk of money from a tax refund can help you put a significant dent in those payments.

“Focus on smaller, more enduring debt like student loans that have just been there forever,” suggests Joy. And you can use your tax refund to help your kids avoid it if you don’t have student loan debt of your own. “Maybe you put half toward your student loans and half toward a 529 plan so your kids aren’t saddled with that kind of debt in the future.”

Splurge a Little

It’s smart to invest in your long-term financial health, but it’s frustrating to get an unexpected windfall and feel like you don’t get to spend any of it. You may want to set aside a little bit of your tax refund for something fun after you’ve put most of your money toward your big-picture goals.

“It’s okay to invest in your current self,” Joy says. That could be something recreational like a trip with a friend or loved one or professional such as a course or certification that will improve your resume. “Don’t spend it all that way,” Joy advises. “But it’s okay to give yourself a budget for a certain percentage that’s a splurge.”

The Bottom Line

It can be exciting to get a refund at tax time but ultimately, Joy says, a yearly refund shouldn’t be your goal. “That means you’ve lent your money to the government,” she explains. “You could be using that money throughout the year and keeping control of it yourself.”

Be thoughtful about how you use it, however, if you do find yourself with an unexpected refund. Invest in your long-term financial health by paying down debt, planning for emergencies, or saving for retirement. It’s okay to have a little fun with your money, however, after you’ve got those covered.

“Everyone needs a splurge now and then,” Joy says. “Just be smart about how you’re spending that money.”