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Updated August 12, 2020

What is a Refund?

Refund can refer to the amount that the Internal Revenue Service will pay to a taxpayer based an overpayment of estimated tax or employer withholding taxes during the year. 

A refund also refers to the procedure where an issuer refinances outstanding bonds by issuing new bonds.

How Does a Refund Work?

During the year, a taxpayer is obligated to make estimated tax payments to the Internal Revenue Service. This may be done directly by the taxpayer or through an arrangement with the taxpayer's employer to pay that tax on his or her behalf. At the end of the year, the taxpayer files his or her tax return to the Internal Revenue Service with exemptions, deductions, and tax credits.  These may reduce the annual tax obligation and the IRS will refund the difference.

With respect to the later definition, a bond issuer may decide to reduce the interest cost or to remove a covenant imposed by the terms of a bond.  By refunding the bonds, the issuer actually issues new bonds and uses the proceeds to repay the debt service or retire the outstanding bonds of the prior issue (i.e. original bond issue being refunded).

Why Does a Refund Matter?

Tax refunds are an important boost for a taxpayer.  By overpaying the IRS, the taxpayer gets a sudden shot of cash; however, it is without interest.  To that end, it is important to elect to designate all eligible exemptions on employer withholdings and to accurately estimate quarterly tax payments to the IRS.

Bond refunding is an important strategy for issuers to use when the terms and conditions of a bond issue become too onerous, especially when market conditions change.  Important to note that refunded bonds are not considered part of the issuer's debt because the lien of the holders on the refunded bonds is on the deposited bond proceeds (i.e. from the refunding), and not on the issuers source of revenues to pay the original bonds. 

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