Federal Refunds Not Taxable
As of 2010, your federal tax refund is not taxable. The IRS does not consider federal refunds to be income for tax purposes because it does not allow you to deduct your refund from your taxable income. State refunds, however, are taxable, and you can deduct them from your taxable income on your federal returns.
If you overpay taxes during the course of the year, the federal government sends you the difference between the tax you owe and the tax you paid once you file your taxes. The most common reason for a tax refund is that your employer withheld more in taxes over the course of the year than you owed. Self-employed people can receive refunds as well if they overpay estimated taxes. In some cases, deductions lower your tax obligation and contribute to a refund.
If your employer withholds too much tax throughout the year, you may get a large refund check in April. However, that money will not be available to you during the course of the year because it is taken out of your paycheck. Thus, you should consider whether you'd rather get a large federal refund in April and less pay during the year or get larger paychecks during the year and a smaller refund in April.
You may be able to get a larger refund due to tax deductions. Many people take a standard deduction rather than itemizing deductions because they don't realize that they can get a larger deduction through itemizing. You can deduct business expenses, medical expenses and charitable contributions. Check with your tax professional if you are unsure about the rules for a particular deduction, as the IRS can audit your return and penalize you if you take deductions you are not entitled to.