When you overpay on your taxes for a given year, the government refunds you whatever amount you overpaid via a refund. Typically, people use this refund like a work bonus, buying things they need or want, or they simply set it aside in a bank or investment account. However, you also can apply your state refund to next year's taxes.
Unexpected life events like job loss easily deplete financial accounts. Thus, even if you plan well, it's not entirely possible to foresee what your money situation will be like in the next tax year. You can't guarantee that applying your state refund to next year's taxes will eliminate the need for you to pay Uncle Sam entirely, but you can at least know that you will not need to come up with the amount of the refund you apply. Essentially, this tactic puts money aside in a time of plenty just in case the following year is a time of lean. Doing this keeps your cash flow and budget more stable.
Penalties for Underpayment
Sometimes, it is necessary to pay estimated taxes, such as if you are self-employed. Unfortunately, estimates aren't always representative of the amount you truly end up owing. In some cases, you may underpay. Doing this results in penalties. If you apply your refund to the following year, you have a cushion that reduces the likelihood of a penalty for underpayment.
When you apply your refund to the following year, it becomes harder to seize it for unpaid debts under bankruptcy, according to the Law Office of Dave Falvey. This means the refund can't be counted as part of your estate if you file for bankruptcy. Preemptively paying your taxes thus shields your refund from being collected in a bankruptcy judgment.
If you itemize deductions, you usually have to count some or all of your state tax refund as taxable income the following year. If you apply the refund to your taxes for next year, however, you no longer have the refund as income. You thus will have to pay less in income tax.
Because everyone's financial situation is different from year to year, there is no hard and fast rule as to whether you should apply your refund to the next year. Additionally, you do not have to apply all of your refund to the next year's taxes. You can apply whatever amount you like.